Matter costs need to be properly recorded in the accounting records due to their tax implications and compliance requirements. To track these costs properly, firms need to determine which category an expense falls into: hard cost or soft cost.
Hard costs are any advanced payments the firm puts out to cover matter expenses. These types of costs are typically passed on to the client. Examples of hard costs include filing fees, expert witnesses, and court reporters.
Hard costs should be attributed to one of two categories: reimbursable client costs or advanced client costs. Reimbursable client costs are generally used when you expect to be reimbursed in the near future. Advanced clients are considered a loan according to the IRS and are meant for expenses that will be reimbursed in the long-term or not at all depending on the case outcome.
How to record:
Reimbursable client costs should be listed as an expense account on the Profit & Loss Statement.
Advanced client costs, given their loan status, should be listed as an Asset Account on the balance sheet.
Soft costs are those related to the normal cost of business, such as printing, data storage, and phone calls, and are normally not charged directly to the client. However, rather than simply absorb these costs, some firms do add a general overhead fee to client invoices.
How to record:
Soft costs are recorded in the firm costs accounts as an expense on the Profit and Loss Statement. If a cost is reimbursed, it should be posted to its own income account, In-House Reimbursed Costs. For costs that the firm does not seek reimbursement, those should be recorded as a matter cost but reflected as a Non-reimbursable Client Costs.
Choosing which account to record costs to is critical to avoiding increased tax liability or causing issues during an IRS audit. You should check with your bookkeeper or accountant as to the proper costing method to avoid incorrect tracking and a possible reduction or increase in your firm’s net income.