Advanced client costs

This week we're gonna talk about advanced client costs. And I know we've done this topic before, but this time I'm gonna talk more about how it works and not so much specifically on a hard cost or a direct cost as opposed to an indirect cost. We have other articles on that topic, so I don't wanna deep dive into something we've already touched upon. But this one's really about if you work with attorneys and law firms, you're going to find out there's complexity in the expenses that the, the law firm will spend money on. There's overhead and then there's client costs. And when you get a new client, you really wanna take a moment to really look at how those are stated in their books. Are they booked in as billable expenses, or are they booked in as advanced client costs, which is an asset account? You want to see if they're doing it old school method. I call it the old school method where they're booking them in as billable expenses as opposed to the proper method. The method the IRS wants to see is advanced client cost. So why does the IRS want to see that in such a fashion? Well, the client may get a deposit or retainer and hold those funds in a liability account and in a bank account that's special, a trust bank account that keeps the funds separated from their actual, actual operating funds. And monies that they have in their firm. That's law firm funds. So we keep it separate. And in that cost that the client has asked for upfront, I'm sure in part of that they may be asking for fees, especially depending on the practice area. So there may be filing fees. Those are direct costs. Uh, they may be expert witness fees if you're in a, a case or a matter that requires that type of— that type of fee. So you might have expert witness fees, you might have a court reporter fee, you might have process server fees. There's just a lot of fees that are involved in working with attorneys and law firms. And typically you'll see that on an invoice when the attorney bills back for these fees, you will see the legal fees or the legal services, the, the work that the attorney has done. And then you'll see underneath that the expenses that they're recouping. Mm-hmm. Advanced client cost. That asset account is, is an asset for a reason. So you're giving a client a loan out of your operating fees to pay for expenses in the case before the case has happened, and typically they'll do that by the fee, or pay for the fee, pay for the process server, pay for the filing fee, and then when they bill at the end of the month or the next month, they'll recoup that and then they'll take that money that they already have as a retainer and apply it to the invoice. I hope you're still following me. And it's a little bit complex. So when we're talking about these fees, the advanced client cost fees or the advanced fees are mini loans to the client until the money is recouped. And that's how the IRS wants to state it. I could see how people get confused, because if you already collected the money for these fees, how is that a mini loan? Then they put it in as a billable expense, and then when they They bill it back, they put it in billable income, it nets to zero. The problem with that method is you skew the books for the attorney, which you might find when you get clients from law firm clients. You'll look at the fees and say, okay, they had a lot of expenses and the net income may be really small because they spent a lot of money on expenses. And in reality, they're gonna get that money back. So then the next year they might have a lot of billable expense income. So it really doesn't keep their books to a financial place that they can actually accurately measure how the firm is doing. So think of advanced client cost as an in-and-out account, almost like a clearing account. The funds, the fees go in when they're paid for out of the operating, operating account, operating bank account, and then they come out when they're billed, and then the bill is paid. By the trust funds. You move the funds over and it clears that all out. So they don't really affect the attorney's books at all. The only time a client advanced cost would affect the attorney's books is if— I like to think of it as a personal injury attorney. They take on a case or matter, they pay these fees up front, and then they don't win the matter. When they don't win the matter or the case, then now the case is over. The person goes on their merry way and the attorney footed this money and with contingency they don't get paid unless they win. So those expenses need to be dropped down into the attorney's books so that they're— are true, become true expenses for the law firm. And not that that happens very often. I know with contingencies usually there's a lot of winning or negotiating going on and they usually end up at least getting the expenses recouped. Mm-hmm. But you do need to stay on top of that with the law firm. There's a lot of communication that has to go on when you work with a personal injury attorney. If for not only that reason of tracking the client expenses, but also for cash flow, because it, it can really eat up the cash flow when the attorney's putting all these— expending their money for all these fees, and then not having that retainer set aside to cover them. Some law firms, personal injury, do take a retainer as part of their practice. You want to really get a good look at what they have for an agreement with their clients, so you understand what they're presenting to their clients. You can probably book it in your book, in the law firm's books. I think that that's definitely critical. You might see in some states you're allowed to pay directly out of the trust fund for the expense, for the client's expenses. So when that happens, it's a matter of booking it into the retainer. You're getting the money from, from the client and you're putting it in his own, his or her own individual ledger. And then when it's paid for the expense, you are allowed to pay that out of, uh, the expenses. Definitely look at the Bar rules for that and make sure that you're stating it properly. And that's just a matter of booking it into the, the client ledger account and booking it out. You don't have to put it in any kind of fee. Sometimes I see clients that have quite the array. They'll have client fees or billable expenses, and then underneath it they'll sub down process server, court reporter, expert witness, filing fees. There's no need to do that. You don't need to track that in that fashion because it's not really— if it's paid out and then recouped, you don't need to know what expense that is because it's not really your expense. I also see sometimes where, if you're working with a rather large PI firm, I've seen people actually state the advanced client cost account just like a trust liability account. They'll make that hierarchy of all the clients and the ins and outs per matter, so that they can keep it straight and be able to reconcile this account at month's end. While I don't recommend that, because it really can make really make it hard to navigate and keep on top of expense, the client expenses. And, and it's— it makes it easier for reconciliation, but it can really make for a cumbersome chart of accounts. Uh, really, that's your call, a personal call, depending on the firm. I mean, you might find it necessary because advanced client cost is so difficult to reconcile. So it's up to you whether you want to take on that extra action. It's okay if you do it. You can always collapse it when you give the returns to the Yes, you can always collapse it when you give the balance sheet to the tax professional, but know that it's just a method of reconciliation, and most people find that not necessary, especially if a firm is using an outside billing fee, billing software. So like LeanLaw or Clio, we're kind of reconciling to— well, not kind of, we are reconciling to the balance that's inside the legal software. So I go into LeanLaw, pull up the expense category at the end of the month, whatever that balance is, that's my balance that I should see in QuickBooks under that same category. And of course, LeanLaw reads the advanced client cost account. It should marry back to it. And you wanna clear off the things that have happened. So you wanna clear up the, the ins and outs so that it reconciles beautifully. But it's an account you definitely wanna add it on. You're not gonna get a bank statement. So you wanna add that on your task list that you need to reconcile advanced client costs to keep it clean and also give the attorneys the expenses that they deserve. If they are putting all the expenses in, then a matter closes and something comes in after the fact, it's like $15. You can go to the attorney and say, look, there's $15 here that the client actually owes. What do you want to do with that? Most of the time they'll just say, just write it off, write it down. And then you just bring it down as in a journal entry, taking it out of advanced client cost and booking it into billable expenses because now it is an expense for the client. for the law firm client. So it would be debiting billable expenses, crediting advanced client cost, and then you're going to get that out of that category. I hope this is helpful. There's a really long article that goes along with this that kind of walks you through some of these, these tips. But I hope this is helpful. And if you're interested in learning more, join the Accountants Law Lab. Bye now.