7 Trust Accounting Red Flags That Trigger Bar Audits
Updated November 2025
Trust accounting red flags are the warning signs that indicate compliance problems in how your law firm handles client funds. State bar auditors are trained to spot these patterns, and discovering them during an audit is significantly worse than catching them yourself. The seven red flags below represent the issues most likely to trigger scrutiny, investigation, or discipline. Each one is detectable through proper oversight - and each one is preventable.
Red Flag #1: Trust Account Balance Doesn't Match Liability Balance
Your trust bank account balance must equal the total liability you owe clients at all times. When these numbers diverge, you either have more client money than you've recorded owing (unidentified funds) or less money than you owe (a shortage). Both scenarios indicate a problem.
Why it matters: This mismatch is the first thing auditors check. A single report comparing bank balance to recorded liability instantly reveals whether your records are accurate. Discrepancies suggest posting errors, missed transactions, or worse.
How to catch it: Run a liability reconciliation monthly. Your practice management software or accounting system should produce a report showing total client funds held versus bank balance. If they don't match, investigate immediately using your trust account reconciliation process.
Red Flag #2: Three-Way Reconciliation Never Actually Completed
Firms often believe they're reconciled when they've only completed partial reconciliation. True three-way reconciliation requires matching three separate figures: your adjusted bank balance, the sum of all individual client ledger balances, and your master trust ledger. Matching just two of three isn't reconciliation - it's a gap waiting to surface.
Why it matters: Partial reconciliation can mask serious problems. Your bank balance might match your master ledger while individual client ledgers contain errors that net to zero. An auditor examining client-level detail will find what your incomplete process missed.
How to catch it: Document all three figures explicitly each month. Your reconciliation report should show bank balance (adjusted for outstanding items), client ledger total, and trust register balance - with all three matching. If your current process doesn't capture all three, you're not actually reconciled.
Red Flag #3: Client Funds Commingled With Operating Funds
Client trust funds and firm operating funds must remain completely separate. Commingling occurs when client funds are deposited into operating accounts, when operating expenses are paid from trust, or when earned fees sit in trust longer than rules allow. Any mixing of these funds violates Rule 1.15 in every jurisdiction.
Why it matters: Commingling is among the most serious trust accounting violations. It suggests either ignorance of basic rules or intentional misuse of client funds. Neither explanation satisfies a bar auditor.
How to catch it: Review your chart of accounts to confirm trust and operating accounts are completely separate. Audit your deposit process - who decides which account receives incoming funds? Check that earned fee transfers happen promptly after billing, not months later. Look for any operating expenses paid from trust (there should be none, ever).
Red Flag #4: Negative Balances on Individual Client Ledgers
A negative balance on any client ledger means you've disbursed more for that client than they deposited. The shortage was necessarily covered by funds belonging to other clients. This is commingling by definition, regardless of whether the overall trust account shows a positive balance.
Why it matters: Auditors examine client-level detail, not just account totals. A trust account with $50,000 and a positive balance looks fine -until examination reveals one client is negative $3,000 and another client's funds covered the gap. The positive total masked a serious violation.
How to catch it: Run a client balance report weekly, not just monthly. Set up alerts in your practice management software to flag when any client balance approaches zero. Implement controls that prevent disbursements exceeding available client funds. When negative balances occur, fix them immediately.
Red Flag #5: Dormant Funds Sitting Without Activity
Client funds held in trust should have a purpose. Retainers get applied to invoices. Settlement funds get disbursed. Cost advances get spent or refunded. When funds sit untouched for months, something is wrong - either the matter concluded without proper closeout, the client is owed a refund that was never processed, or the funds were misallocated and belong to someone else.
Why it matters: Dormant funds raise questions about firm processes and attention to client matters. They also create escheatment obligations under state unclaimed property laws. An auditor seeing multiple dormant balances will investigate why.
How to catch it: Run an aging report on client trust balances monthly. Flag any balance with no activity for 90+ days. Investigate each one: Is the matter active? Are funds still needed? Should they be refunded? Document your review and conclusions.
Red Flag #6: Disbursements Without Supporting Documentation
Every trust account disbursement should tie to supporting documentation: an invoice for fee transfers, a receipt for cost reimbursements, a settlement statement for distributions, written client authorization for refunds. Disbursements without backup look like unauthorized withdrawals - even when they're legitimate.
Why it matters: Documentation proves that disbursements were proper. Without it, you cannot demonstrate compliance even if you did everything correctly. An auditor will treat undocumented disbursements as presumptively improper.
How to catch it: Implement a requirement that no trust disbursement processes without attached documentation. Review disbursements monthly to verify documentation exists. For older transactions missing backup, reconstruct documentation from available sources (emails, invoices, settlement statements) and note the reconstruction in your file.
Red Flag #7: Ledger Adjustments Without Review Trail
Practice management software makes it easy to adjust client ledger balances - correct an error, move funds between matters, fix a misallocation. But adjustments without oversight can mask larger problems or create new ones. Who made the adjustment? Why? Was it reviewed by someone other than the person who made it?
Why it matters: Unexplained adjustments are audit magnets. They suggest either sloppy recordkeeping or intentional manipulation. A pattern of adjustments without documentation indicates systemic control weaknesses.
How to catch it: Pull an adjustment report monthly showing all manual changes to client ledgers. Require written explanation for every adjustment. Implement dual approval for adjustments above a threshold amount. Review the adjustment log as part of your monthly reconciliation process.
Why Software Doesn't Catch These Red Flags
Legal practice management platforms like Clio and MyCase provide excellent trust accounting infrastructure. They maintain client ledgers, generate reconciliation reports, and create audit trails. But software cannot evaluate whether your processes are actually followed. It records what you enter - it doesn't verify that entries are correct, timely, or complete.
Software will show you that a three-way reconciliation report exists. It won't tell you that the reconciliation was done properly. It will record an adjustment to a client ledger. It won't ask whether that adjustment was appropriate.
The red flags above require human judgment to identify. Software provides the data; oversight interprets it.
Building a Red Flag Detection System
Catching problems before auditors do requires systematic review, not occasional spot-checks.
Weekly Reviews:
Client balance report (flag negatives and near-zeros)
Outstanding check list (flag items over 30 days)
Pending deposit review (verify proper client attribution)
Monthly Reviews:
Complete three-way reconciliation with documentation
Dormant balance aging report (flag 90+ day inactivity)
Adjustment log review (verify all adjustments explained)
Disbursement documentation audit (sample 10-20%)
Quarterly Reviews:
Full reconciliation back-check (verify monthly reconciliations were accurate)
Matter closeout audit (ensure closed matters have zero balances)
Process compliance review (are procedures being followed?)
Document every review. The documentation itself becomes evidence of your compliance efforts if questions arise later.
When Red Flags Have Already Appeared
If your review uncovers any of these red flags, don't wait. Address them immediately following the process outlined in our trust account violation guide.
The difference between a minor issue and a major problem often comes down to how quickly you respond. A negative client balance corrected the same day it's discovered looks like a caught error. The same negative balance left unresolved for three months looks like negligence - or worse.
Document what you found, what caused it, and what you did to fix it. Then implement controls to prevent recurrence. Auditors treat self-identified and corrected issues far more favorably than problems they discover themselves.
Protecting Your Practice
Trust accounting compliance protects three things: your clients' funds, your license, and your firm's reputation. The red flags above are early warning signals that one or more of these protections may be compromised.
Regular oversight catches problems when they're small and correctable. Skipped oversight lets problems compound until they threaten everything you've built. The choice is straightforward, even if the work isn't.
Your IOLTA compliance depends on consistent attention to these warning signs. Monthly reconciliation isn't paperwork—it's protection.
How to Avoid a Trust Account Catastrophe
Relying solely on software for trust compliance is risky. While legal accounting software can automate various tasks, it cannot replace the vital oversight provided by a human expert. Software might overlook nuances in trust accounting that can result in compliance violations, such as subtle misclassifications of funds or the neglect of regular reconciliations. If client funds are mismanaged, you could face scrutiny from law enforcement - especially if there’s a pattern of trust account errors. Your attorney trust account must reconcile perfectly with your client ledger - every single month.
A dedicated legal bookkeeper does more than just manage your books - they safeguard your license, your clients, and your peace of mind. They make sure your trust accounts are maintained with accurate records and timely reconciliations. By identifying potential issues before they escalate, a bookkeeper helps prevent ethical breaches and financial penalties. Legal trust account problems aren’t just clerical - they’re regulatory landmines.
One mistake. One mis-categorized transaction. That’s all it takes to trigger an audit - or worse.
Want a second opinion on your trust accounting for law firms? Book a review and we’ll flag the risks before the bar does.
We’ve seen the same common trust accounting mistakes cost law firms thousands - and they’re all avoidable. Let’s make sure that never happens. Clean, up-to-date financial records are your first defense in an audit or investigation.
Book your discovery call now - and see what clean, compliant books should really look like.
Frequently Asked Questions
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Trust accounting red flags are warning signs indicating potential compliance problems in how a law firm handles client funds. Common red flags include mismatched bank and liability balances, incomplete reconciliations, commingled funds, negative client ledger balances, dormant funds without explanation, undocumented disbursements, and unsupervised ledger adjustments. Auditors are trained to identify these patterns.
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Review client balance reports weekly to catch negative balances immediately. Complete full three-way reconciliation monthly with documented review of dormant balances, adjustments, and disbursement documentation. Perform quarterly process audits to verify procedures are being followed consistently. More frequent review catches problems faster.
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Software provides the data but cannot evaluate whether processes are followed correctly. Practice management platforms like Clio and MyCase generate reconciliation reports and maintain audit trails, but they record what you enter without verifying accuracy. Human oversight must interpret the data and identify patterns that indicate compliance problems.
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Negative balances occur when disbursements for a client exceed their deposits—meaning other clients' funds covered the shortfall. Causes include processing costs before replenishment, fee transfers exceeding available retainer, refunding more than was held, or posting transactions to the wrong client. Negative balances require immediate correction regardless of cause.
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Funds sitting without activity suggest incomplete matter closeout, owed refunds never processed, or misallocated funds. Dormant balances also trigger state unclaimed property obligations if held beyond statutory periods. Auditors viewing multiple dormant balances will investigate whether proper client fund management procedures exist.
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Every disbursement needs supporting documentation: invoices for fee transfers, receipts for cost reimbursements, settlement statements for distributions, and written client authorization for refunds. Documentation proves disbursements were proper and authorized. Without backup, legitimate transactions appear improper during audits.
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Require written explanations for every manual adjustment to client ledgers. Implement dual approval for adjustments above threshold amounts. Pull monthly adjustment reports and review as part of reconciliation. Unexplained adjustments suggest sloppy recordkeeping or potential manipulation-both attract auditor scrutiny.
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Consequences depend on severity and response. Minor issues with documented correction efforts typically result in guidance or private reprimand. Patterns of negligence may trigger required audits, fines, or public discipline. Serious violations involving actual client harm or misappropriation can result in suspension or disbarment. Self-identified and corrected issues receive more favorable treatment.
