Not all invoice payments can be directly recorded as revenue, and doing so can have negative repercussions for the firm including an unnecessary tax liability. Law firms need to apply payments in the appropriate order once payments are received.
Payments should be applied in the following order once taken in:
- Cost recovery, including reimbursable client costs
- Late fees and finance charges
- Fee income
The result of this payment application can mean a lawyer doesn’t receive actual income if only a partial payment is made, as the costs need to first cover the highest priority items.
Firms should be cautious of using generic accounting tools such as QuickBooks to handle this payment allocation, as this often needs to be manually handled through adjustments. In order to avoid the risk of improper allocation, some firms create separate invoices for costs and fees and then apply payments to the invoices in order of the above allocation schedule.