A new generation of trust accounting technology has been recently developed (and patented) to make trust financial solvency its primary objective while automating daily trust transactions. The solvency concept as well as the double-entry accounting practice employed by for-profit organizations has been adapted and introduced in the trust accounting practice regardless of the organization’s type of business (whether for profit or not). Balance Sheets and Trust Float Statements will be available for each trust funds beneficiary, especially critical when there are multiple trust beneficiaries in a single trust account.
Trust accounting is commonly used in the real estate (RE) industry (escrow accounts) and legal profession (attorney’s trust accounts); other industries also use it. Guidelines to RE brokers for trust accounting procedures have been issued by different states to help bookkeepers create reliable accounting records and for trustees to avoid fiduciary violations. Several software vendors offer trust accounting products to attorneys (listing on Capterra website) to help them separate trust funds from business operating funds and establish trust account beneficiaries.
P&C Insurance
An industry where trust accounting is not fully recognized by professionals is the property/casualty (P&C) insurance brokerage industry. P&C insurance trust accounts are much more dynamic and more demanding than the escrow and/or attorney’s trust accounts; they are subject to heavy daily financial traffic and have requirements nonexistent in other industries. The existence of P&C trust accounts is not acknowledged by major national institutions entrusted with regulating or standardizing accounting practice, such as American
Institute of CPAs (AICPA) and Financial Accounting Standard Board (FASB). The AICPA Tax Division published in 2007 a Practice Guide for Accountants who perform fiduciary accounting services. Alerted to the problem of P&C insurance retailers’ inadequate income accounting practice, the FASB is yet to provide a solution.
Trust Funds
Trust funds are money, or any other property, received by a broker in a fiduciary capacity to manage it for the benefit of others (legal owners). The law requires brokers to maintain trust funds in trust bank accounts separate from the broker’s business operating funds. Fiduciary capacity is understood as an obligation to manage trust funds not as owners but custodians of funds until they are disbursed to the persons legally entitled to. Diverting trust funds or appropriating them for personal use is a fiduciary violation.
AICPA defines the fiduciary relationship as undivided loyalty to trust funds beneficiaries. It requires an above-reproach conduct and a high standard of care for negligence. AICPA also defines the trustee’s fiduciary duty as: 1) duty of management to preserve and protect the trust property, 2) duty of loyalty to keep the interests of trust beneficiaries ahead of those of third parties, 3) duty to account, to keep accurate records of trust funds, and 4) duty to disclose trust information to trust beneficiaries as such information belongs to beneficiaries as much as to the trustee.
Trust Accounting
It is significant to note that, although the custodian’s ultimate fiduciary duty is to keep the trust account financially solvent, the state-issued trust account guidelines for RE brokers do not specifically identify solvency as a management target. They seem to imply that merely keeping accurate trust records would inherently guarantee the trust financial solvency. The notion of “trust assets and liabilities” as well as “trust balance sheet” does not exist. It is apparent the guidelines consider the keeping of receipts and disbursements journals and ledgers of trust beneficiaries is sufficient; an accountant will determine if the escrow account is financially solvent.
P&C Trust Accounting
Compared to those in the real estate and/or legal profession, trust funds accounting procedures in the P&C retailing industry are quite different. While trust fund transactions in either RE or legal professional practice generate no “income”, in the P&C retailing industry, due to a 45-year old unfortunate practice, premium invoice does create “income” records. The invoice accounting was erroneously set up so that while invoice payments are deposited in the agency’s trust account, the income accounting records are maintained in the agency’s general ledger. The ensuing result is an accounting mess that causes agency’s owners to have no control over premium trust funds while exposing them to potential fiduciary duty violations.
The State of California, for example (and similarly other states), requires agency owners, acting as “trustees”, to provide proof of solvency i.e., proof that there are sufficient premium assets in the trust account to meet the trust liabilities (obligations to P&C trust beneficiaries). Such proof requires elaborate accounting since there can be multiple beneficiaries in a P&C insurance trust account: insurance companies, insureds and premium finance companies, and agency itself (owner of earned commissions).
The erroneous set up of the P&C premium invoice accounting made it impossible for agency owners to have “trust account balance sheets” and/or “premium float statements”. The latter would have the information necessary to determine trust funds beneficiaries; the former would enable accountants to establish the trust cash financial solvency (liquidity solvency in general business accounting) based on accounting records (no formulas).
The most egregious downside of P&C agency’s current trust accounting practice is its inability to support agency income accounting necessary to determine the agency’s “earned” commission income. Most agencies transfer commission funds to their operating accounts based on what they “need” rather than what they “earn”. The uncontrolled transfer of commission funds out of the agency’s trust account is a major source of trust financial insolvency.
Hybrid Trust Accounting
With the advent of a new accounting logic for trust funds, it became necessary to distinguish the current hybrid trust accounting practice (used in RE and legal profession) from the new trust accounting technology. The new trust accounting logic is founded on trust financial management requirements:
- Complete separation of trust funds from the brokers’ business operating funds using a separate trust ledger of accounts. This requirement is currently met in the RE industry where commingling of non-fiduciary funds in the escrow account is not permitted. This is not the case in the legal profession and/or P&C insurance brokerage industry;
- The trust ledger must have a chart of accounts with sufficient detail to support trust balance sheets and statements of trust float;
- Trust Balance Sheets can be easily processed to generate trust financial solvency reports, especially trust cash financial solvency (liquidity statement in general business accounting); trust accounting is “cash accounting”, no funds can be disbursed out of the trust account before related cash or credit funds are deposited;
- The Trust Float Statement can be easily processed to generate Trust Funds Beneficiaries Statements, especially when multiple beneficiaries are present in the broker’s trust account;
- No manual journal entries should be permitted in trust accounting; all trust accounting transactions should be fully automated, i.e., programmed and executed by computer;
- Financial solvency reporting should replace current journal and/or ledger reporting system so brokers and auditors can easily and instantly verify trust account financial solvency;
- Financial solvency reporting will demonstrate:
- Trust assets equal trust liabilities;
- Trust cash balance equals the trust account float;
- Trust cash assets equal trust “due and payable” liabilities (cash solvency);
- Trust cash balance calculated for all beneficiaries equals the trust account float;
- Financial solvency is reported for each trust account beneficiary.
Conclusions
Trust accounting products offered to attorneys (see Capterra website) or escrow companies are functional in as much as they provide on journals and/or ledgers information regarding trust receipts and disbursements, trust funds beneficiaries, etc. They do not explicitly report financial solvency.
Brokers and auditors do not find direct answers to the trust account financial solvency question. Escrow final statements are generally cumbersome, difficult to read even by people with knowledge of trust transactions. A CPA confidentially admitted the trust accounts of his client-attorneys were messy.
Because of limited accounting procedures and lack of trust financial solvency reporting current trust accounting products are hereby referred to as “hybrid” products. The new trust accounting product is branded T-Trust Accounting (T for True) or NOBL Trust Accounting. It is fully automated and performs as detailed in the above 7-item list of solvency management requirements.
The new trust accounting technology stands to change current trust accounting practice with great benefits to accountants, trustees and trust beneficiaries. It is currently available only to P&C insurance brokers; it will be also ready for distribution in other industries during the months to come.
Article written by Chris Marinescu, Founder and President at Paulmar Group LLC and Emma Hart, Industry Consultant. For more information on T-Trust Accounting contact the author or Emma Hart by email: chris@paulmargroup.com or Emma@emmahart.com A link to our US Patent is also provided:
https://www.paulmargroup.com/technology/PressReleaseJun2018.html
