Every law firm deals with matter expenses that are billed to their clients. All of these costs need to be accounted for, which would be easy if it weren’t for the fact that not all costs are treated the same. Thankfully, matter cost accounting software is available to make sure you’re handling these client expenses correctly and to help you avoid any tax compliance issues.
Matter Costs Explained
Matter cost accounting involves costs being paid in advance by the law firm during the course of a case. Properly tracking the posting and reimbursement of these costs is essential to making sure the firm’s accounting records are in compliance with legal accounting standards. One of the first steps in proper matter cost tracking is determining which category these expenses fall into.
Law firms typically have two types of matter costs: hard costs (direct costs) and soft costs (indirect costs).
Hard costs cover matter expenses with advance payment to vendors by the firm for things like court reporters, filing fees and expert witnesses and can be billed directly to the client.
Soft costs cover items involved with the normal course of doing business. These in-house expenses include items such as copy and fax charges, data storage, and phone calls. Some firms absorb these costs, some may add a general overhead fee to client invoices, while others choose to itemize these expenses individually.
Pitfalls of Matter Cost Accounting
Dropping Billable Expenses
One common theme with matter costs is reimbursement. A majority of the time, the firm is seeking reimbursement for these out-of-pocket costs. Unfortunately, what often happens is that the expense is recorded from an accounting perspective but forgotten and never billed to the client. This is most common when accounting and billing records are tracked separately or in different systems. Failure to associate a matter with a cost means the expense will never make its way onto a bill and leads to a leakage in profit for the firm, which is completely preventable.
Incorrect Recording of Costs
Recording client expenses and correctly identifying them as a hard or soft cost is critical as the accounting is handled differently for each.
For accounting purposes, hard costs can be classified as one of two categories:
Reimbursable Client Costs is an expense account on the Profit & Loss, typically used for short-term billing in which you expect to be reimbursed in the near future.
Advanced Client Costs is an asset account on the Balance Sheet, which is typically for costs which may be reimbursed in the long-term or not at all such as in a contingency case. The IRS clearly specifies in their Attorney Audit Technique Guide these costs are considered a loan to the client until the case is settled and should be treated as such in the accounting process.
Soft costs, on the other hand, are handled very differently since the expense is already accounted for in firm costs, but the reimbursement does get recorded to its own income account – In-house Reimbursed Costs.
Lastly, you may have costs you choose not to seek reimbursement for. Those still need to be recorded as a matter cost but would be reflected as a Non-Reimbursable Client Cost.
Deciding which accounts to record your expenses under is a critical decision and should be made with your bookkeeper or accountant. Incorrect tracking can lead to a reduction or increase in the net income of a firm. Over the tax year, this creates an increased tax liability and can present a significant red flag during an IRS audit.
Matter Cost Accounting Software Benefits
Using matter cost accounting software makes it easy to input client costs correctly. Legal-specific programs, like CosmoLex, are built to let you post expenses as they occur no matter how they’re paid. You can even import credit card statements or post a cost from your mobile app. Simple posting means expenses are less likely to slip through the cracks, making sure your firm recovers costs incurred.
Matter cost accounting software will also ensure each expense is linked to a matter, labeled as a hard or soft cost, and automatically posted to the proper account. Completing these three key tasks for every client expense establishes compliance.
All of the nuances involved with client expenses can be readily handled by a legal-specific matter cost accounting software to provide your firm with accurate profitability, tax liability and accounting compliance.