Advanced Client Costs for Law Firms

Welcome to Accountants Law Pod, where accounting professionals and law firms converge, hosted by Linda Artesani, Sarah Prevost, and Steven Libhart.

Welcome back to the podcast, everyone. Today we have a very law-specific topic, and it's advanced client costs. And I think it's probably a topic when we talk to attorneys, sometimes they're a little bit confused on this. This is going to be a really good conversation because There's a few ways we've seen it on the books, and we'll probably get into that a little bit. And I always toss it to Steve, so I'm going to toss it to Sarah this time. Oh, I woke her up to see if she wanted to talk about advanced planning costs. What are they, Sarah?

Well, I'm just going to let the truck go by. So advanced planning costs, the simple way to say it is when you're advancing costs ahead of being able to charge for it. So for— you have a case where you have medical filing fees, those sorts of things. And so you're giving a microloan essentially to your client for a moment of time. And, and then you will be able to recoup that, those expenses separate from your legal fees on your billing. The thing I think that becomes a bit challenging is, how do we treat those? So some clients have it all on their P&L. Essentially, it's fine per se, but not really, because what if you've overstated your expenses that year and you're collecting on those expenses in a future year? So you have a crossover year.

That's like a personal injury attorney.

Yeah, exactly.

Your income when you—

your income. Yeah, but really through the lens of when you read the, the coding from the IRS that That is actually not the treatment for it. Now there are ways in accounting method to change these and do these things differently where you can hold them in one place and then you balance them back and put them in the proper financial statement. There's the other method which you just have to get really under— you have to understand from our perspective we have to get really detailed about this is okay you are charging in advance of incurring the fee, which I've seen more and more because it's a flat rate, this filing fee, it's an understood rate, not a problem. Then let's go ahead and identify when you pay for that fee that we can correlate that to who you've charged and make sure that lines up on your financial statement, which would be on your profit and loss correctly. So that is a method we're seeing. I mean, it's tricky for some. And it's not an easy one to reconcile, I guess you could say, right?

And I've heard this called a clearing account. And Steve, you want to argue with me that it's not really a clearing account? Because there are times when it doesn't come in and out, right?

Well, I'm not sure how to answer that. It, uh, I like to do it.

Let's just say they're a personal injury attorney and they upfronted all these costs and then they don't win.

Then it should be adjusted off at the year end.

Yeah.

I like to treat them as cost receivables on the balance sheet, broken out by client, just like we do with the trust transactions. So, you know, we've got Sarah's case, we've got Linda's case, and we just post all those charges there. Then when it's time to settle, we've got a snapshot right away. Now, that should also match the billing system. So I like to tie that back to the billing system every month and see what they've missed and, you know, catch them on it right away instead of 2 years later when they settle the case. And you're trying to figure it out. So keeping them as cost receivable on the balance sheet because it is an asset, it's, it's, you know, something you're going to collect later.

A little loan to the client.

I mean, it is a loan to the client, and that helps with your KPIs when you categorize it that way as well.

Yeah, especially for a personal injury attorney, if not all of them, but especially because they end up, you know, personal injury attorneys, sometimes this is a cash flow problem kind of a scenario, right? You're on contingency. And you're spending all this money to pay for all these expenses for this matter. I mean, they win most of them, but, and usually the faster they can settle it, the faster they get their money. So a lot of these bigger firms have these systems in place to try to get it settled quickly with the insurance. But sometimes if they have to go to court, it takes a lot longer. It can be 2 years, 3 years, or 5 years, depending on the way their jurisdiction. And now this money is sitting there that they've paid out. They don't typically take a retainer. So it's all on the law firm until they win the case, and then they can get that money back plus their legal fees. And that's why you'll see them actually go outside of that, maybe go borrow money from like an advocate capital, which again goes back to what we talked about last week about having to have a good agreement, letter of agreement between the client and the law firm, because Then you're talking about maybe some interest on that loan because they're actually borrowing money to front the cost for the client. And that adds a whole nother world of hurt on our side to track this because we have to track it by the client. That loan is broken down by the client, and so is the insurance. It's a—

Well, and depending on the type of ledger system you have, regardless of which one, you have to be able to make sure that there's a system in place, which is not always the case, that you can be able to track, okay, when that fee was incurred, who does it go back to? What if it's a bulk payment? They're paying for 5 or 6 different ones. Construction litigation, you're going to see a lot of different names inside of there that go to different cases, but maybe the same expert or the same— all these different things. And if you don't do the homework, the hard work at the front end of being able to identify what those costs are and who they belong to—

Who they belong to.

Then you're having a harder time on the other side balancing that. And then a lot of times we see this. It's so true, is you have soft costs versus hard costs. What we're talking about today is technically a hard cost. Those soft costs, those photocopies, postage things, unless they're over a certain amount. Those tend to fall in the soft cost category. We're not talking about those. We're talking about the tangible. I took money out of my law firm's bank account to go operating. Yeah, that operating.

I'll tell you, by tracking it as a cost receivable by client, I had a personal injury attorney that I caught loaning money to his client in advance of the settlement, and I wouldn't have caught it had we not been breaking it down by client.

Yeah, I don't know how legal that is. I guess it's not. I don't think it's legal. Right. So I've seen that too, though, because they're like advancing them the award winnings from the matter that hasn't come to fruition. How can you— what if it doesn't? I mean, yes, they might leave you.

I've seen settlement checks get called back by the bank.

Yes, but that's part of the problem with personal injury attorneys is that— or any insurance type— but we see that happen where the check bounces from the insurance company. It's like, what happened here? So that's another thing. So you have track when the check comes in. And that's a whole nother story about getting that. But I think a lot of times, like Sarah was mentioning, so hard and soft costs is terms you're going to hear working with law firms, indirect or direct. We're talking about the direct expense.

Yeah.

And the direct expense for the client, it'll have the client's name attached. You can't just go booking those into advanced client costs without knowing who they belong to because you'll never be able to get them out. We reconcile that account monthly. We don't make a subset of accounts. We don't go down that road of subbing it out like we do with the trust. But we do put it in advanced client costs, and then when it gets put in and it, and it gets billed back, now it's become billable expense income. And if it's advanced client costs, it's just gonna be advanced client costs in, out. It's kind of like that clearing account. But if they're doing billable expense, it becomes billable expense income. That's your offset, and then you're not having to deal with that reconciliation. But I think it's— it, like Sarah mentioned, this is in the IRS code. that it's really a mini loan and that's how it should be treated on their books. It should not be billable expense and billable income. The older the firm, the more likely you're going to see that scenario of the billable expense and income. We do make an account for billable expenses unrecovered, and that's where we will reconcile that advanced client cost down to if they didn't win the matter or the case closed for whatever reason, and it never went to the end. We'll book it down to get it out because you have to reconcile it. You don't want to leave it up there. It'll stay up in the advanced client cost forever. And it's now become the firm expense because they're not going to get that money back.

It's— but there's also just— we don't, we don't have the tax knowledge for this, but there are some areas that you might not be able to recoup those expenses as a firm depending on the type of case. And that goes into that, that tax space. And that's not something We are able to really speak to, but there, there are reasons why you need to call them out in a separate GL account, to your point, Linda.

Mm-hmm.

And I feel like it is that marriage, as we've talked in our own circles, of the relationship, the financial team that you build, because you really need a strong accounting firm working with a strong tax firm that has your insight of your niche or your area. In line with that. And because we specialize in this space, these are things that we hear and learn. And, you know, and it's an evolving space, don't you agree? Like, you constantly— rules are not going to just stick. They're going to change. Like, how many 1099 debacles have we run into in the course of these last 4 or 5 years? And every year, if the form changes or guidance changes, it throws us in.

It usually changes at the last minute too. At the last minute.

Thank you.

Like, oh, December 31st. 1st, we changed this rule.

Yeah.

But it's funny too, with, um, this is where this legal billing software can be invaluable, right? Because one of my favorite things, I told this to Jonathan, um, at LeanLaw, I said, I call it the look, ma, no hands method with LeanLaw. And he said, what do you mean by that? And I said, well, I push it into Hubdoc for my client. I push the expenses, the client will upload the expenses, and then I will have it Automatically with the client expenses hit advanced client costs, and then I'll go in and put the name of the matter in, or the team will.

We're talking QuickBooks now.

In—

no, in Hubdoc.

In Hubdoc.

Push it into— when it pushes into QuickBooks, QuickBooks LeanLaw reads the advanced client cost account and then pulls it up to the expenses.

I've really—

all I've done is the client has put it in and my team members tagged it the matter. And it's sitting up in the client expenses waiting to be billed back. I haven't really had to touch it. That's why I call it the Look Ma, No Hands method because I really haven't had to touch that, really haven't touched that transaction much at all, right? We just tagged it for the matter. And Clio has the same thing, right? So they, it sees and reads advanced client costs and it books it up there. So then it's sitting there when they do the billing every month, they go to do the billing and the client expenses are there.

I love that.

You write the details in, inside of Hubdoc so it gets pushed in and the details will now populate on the, billing. It's really automation. Right.

So our LeanLaw does it really well. I have a little beef with Clio on it in that—

Oh, do share.

Yes. As much as I love the product, this is one area that I feel it's their two-way section only, this one area. But they have a dependency that a client name will not populate in a ledger system Without a transaction. Well, that's problematic in this situation because there may not be a retainer moment that's happening at that moment. There might be an incurred cost depending on how the firm works.

Right.

And so that to me is a problem. And there's a difference there. But also we're talking about softwares that are not entirely the same too. What we're bringing up are 2 different styles of softwares, to be fair. But anyways, I digressed in that. I just wanted to share that because also that's where an experienced person like ourselves understands this language. We have the time. This is our space, right? And you're practicing law on the other side. You're finding that value of space right there. And there is a lot of information that we do need to know.

So I want to ask you too how you would handle this. You've got your state e-filing systems. A new client comes along and the attorney wants to investigate who this client is and what they can find out about them. So they'll go online and do that, and there's a fee for that. Then the client signs up and becomes a client of the firm, and they, they go out and they start doing filings on behalf of that client, you know, in the courts and those sorts of things. And there's expenses for that. How do you treat Or how would you recommend treating that initial investigation charge of, let's say, $12 is what the state charged to give the information on how they're incorporated and who they are and all that sort of stuff.

This is prior to them signing up to be a client in the firm.

Yes.

So the client does not exist in the firm.

It doesn't exist.

Right. Right.

And so what do you think? More of an expense of the firm, if that's part of what they do, and it would kind of offset their consulting fee.

It's a soft cost.

Yeah. Soft cost is where I would see that.

Now, but I see people get mixed up on that all the time because they're like, well, now they're a client, we should charge them. And it's like, well, that helped you decide as a business whether to take that client or not. That wasn't work on behalf of the client.

Well, what about the fee? I love this question, Steve, because what about there's fees for just monthly charges just to be able to access the portal? Well, now what?

Now what?

Go like hide that. Oh, it's cost of business, right? That's what it is. But do you, I guess I'm gonna ask you both, do you see this where some people are charging like a flat rate of soft costs? Like, okay, you're gonna get charged.

I have seen it. Yeah.

Yeah, I like it. I think it's a great idea because that way they're not counting every copy. I mean, some firms get like really deep into how many stamps they do. How many stamps were licked for this client? It's like, really?

Or copies made in the copy machine.

Copies. Yeah, the copy machine. They have the clicker and they come—

Binders. We used 5 binders for your case.

And you can do it.

Have to do it. Some firms have to do it because they're depending on the practice area, right? Practice area goes back. Yeah, but it, it, it challenges us as accounting professionals of how to understand it and have the knowledge for it. Like To what both of you were saying.

I mean, I remember how eye-opening it was when we did that Canadian client and how the court was very— I mean, they really went very detailed and very—

They have a very different system.

To give them back whatever their award was. They really like— it was a very complex little thing, and they had to have all the documentation to prove every single thing. That's just the way it was. It was interesting to see the difference compared to the US. And every state's different. Every— again, it goes back to if you're a bookkeeper or accounting accountant listening to this, know that you need to know those state rules. I mean, you really should. That should be your first go-to when you're trying to get a client in any different state that's not your own that you don't know the rules on.

Well, do you find it— I found it interesting. I was listening to some friends of ours, their podcast, and they brought up this whole thing that's happening up in Canada where there's a big rift going on with the, um, different provinces, I believe, that are not wanting to stay, like, because their certification is different up there.

Yeah, so everything is different up there.

It's a lot different.

Law Society, right? Isn't it called a Law Society or something like that? Kind of like England?

Yeah, well, in the accounting side of it, for us, it was, it was very interesting to look at those set of books and understand their tax.

They tax their invoices too, so there's a tax when they Oh, do they? Tax on their invoices.

It's kind of fascinating, huh?

Yeah. Different tax. It's like, oh boy, you guys, this is really complex.

So what do we, what do we tell the bookkeeper/accountant who has that gray area on a charge? When in doubt, go ahead and post it as a cost receivable and then write it off later when you're settling the case or finishing it out. Or do we want it on the, you know, do we want it in a suspense account to ask the client about or You know, or do you create a—

what I do sometimes is create a subset. So I have a ledger account that's mostly an ask, but it's categorized in that space.

Okay.

How much they're charged, they've charged for the year or the quarter, if they've recouped. Okay, I see that you've recouped, let's say, $5,000 above the line, but I'm only seeing You know, $4,000 below. What am I missing? Is it the soft costs? That's a, that's a barometer, right? Or there's the other side of it where, um, you have quite a bit of expenses on your profit line. Am I missing something? Did you change your system or are you not accounting for this correctly?

Well, let's go back to the postage example that Linda was using a minute ago. Um, so we bring in a client And we decide that we're not going to charge them for licking stamps. But then suddenly there's a class action lawsuit and we have to send out 1,000 letters. How do we train the staff to be proactive and be involved in this process and raise their hand and say, well, wait a minute, what am I doing with this? True.

I mean, it can be expensive, right? Postage can be expensive if you're looking at that kind of a scenario.

Some can follow the metric. I've seen this and I agree with it. If it's everyday postage up until a certain spot, great. But when I'm sending you a novel and it's $70, at this point we're shipping—

It's direct, right? Because you know what you're spending the money on.

It's a direct cost. Directly to that client. Yes, I expect to see your little FedEx charge, please. Please and thank you.

All right, I got a question for you now. So we're talking advanced client costs today. What do you do? I'll ask both of you this question. I'll ask Sarah first and I'll get Steve.

Oh, gosh.

What do you do when you get a client? This has happened. This is real easy for us, Sarah. So what do you do when you get a client and you look at their books and they've got kind of a— they don't call it advanced client costs. They call it prepaid blah, blah, blah, whatever they want to call it up on the— it's on the profit and loss, but it's called prepaid client expenses.

Okay.

And you know that the whole thing is wrong. Like, how do you address that with the client that It's being booked in not in the right way.

It's just negative on the expense end.

Thank you.

Negative. I knew where you're going. I was like, oh, I think I know.

It's a negative account. Yeah.

Yeah. Client reimbursements.

Yeah.

Prepaid client expenses reimbursed.

Well, and it is, to be fair, I mean, you, a lot of this stems from the understanding there might have been a conversation in a class Or with a tax professional that said, hey, this is how you have to treat this. What they're forgetting is that opposite side of it. You can't— I'm sorry, you, you're recouping it. It's on a bill that should live what I call above the line, just to keep it simple. That should be in the income section. The expense associated with that, as we've discussed, it should be in the expense category. Though that, that thing of accounting plays into this right now. The idea of having a negative expense account is not a proper expense, right? That's not a proper account.

So it's wrong.

Yes, it's wrong.

Check. And then you're gonna have to dig through it, right? I mean, Steve, how about this? Say we have it, it's on the balance sheet, but it's showing as a liability account because they don't— they owe us that money back.

Correct. Correct. And it's got to be moved to the asset side.

Yeah.

And to your point, I've run into this before. I've run into this before where they have it on the P&L and they're in shock that they have this negative balance. And you have to explain to them, you know, this— these expenses could have lived from year to year to year on your P&L, and all of a sudden you get reimbursed for it this year. And that's why you're seeing it as a negative this year on your P&L. And that's wrong. It's, it's, it's It's reporting your numbers wrong.

We had a firm like that that was a large firm, and they had all their expenses were expensed out. So they had a lot of lean years that they had. And this was a case that went on. These are cases that went on for a really long time. So they had a lot of years that were really— they had a lot of expenses. And now a lot of these cases are starting to be won. Now they're having the flip side of that. So their net income is going to go up. Quite a bit. So they didn't have a big net income. And then all of a sudden, because now they have no expenses to offset—

That's just giving you false information.

And that could cause a trigger on your tax return, right?

Because you've got these— Yeah, I think too, if you're looking at through that metric of like how to measure some key areas like Steve brought up, how do you correctly measure then your firm? You're not apples to apples. You might do it this way because that's just how we've done it. I can't tell you.

Every time I hear that, I say, okay, that's how Mildred did it back in 1953. What do you mean I can't do it that way? You know? And it's like, um, okay, then you just pull out the code.

And if you're gonna, if you're gonna go to the bank, let's say your, your firm is growing and you decide to buy a building for tax break.

Okay.

Um, and you're gonna provide financials to the bank. They're going to wanna see those client expenses over on the balance sheet as an asset because it is an asset to the business. And they're going to want to see your accounts receivable collection ratios. And they're going to tie the two together and they're going to come up with a factor for you. And if you have it on the P&L, it just muddies up all the numbers.

And that brings to the point too, that if you're going to fix this for the client, you have the conversation, you explain the code, you go through all that action. I can only fix the current year if you file a tax return.

Oh, sure.

I'm only looking on this one little box of this year to fix it, to make it right for that. And moving it where it belongs for that. But I can't go back into last year. If you took those expenses last year, you're not going to get to take them twice. So that's going to be the problem, and it's going to be a corrective year, basically.

And that leads you into a dialogue with the tax preparer then, saying, you know, we're going to move all of these items now over to the balance sheet. We have this mess left on the P&L, you know, what do you want to do with it? Don't feel like you have to rectify it, but you can, you can Correct the course, if you will, of what's going on in the future for the client costs.

And it should be a conversation with the tax person.

It should be. And it goes back to that process, you know, good process procedures that you create, whether they're kind of a hybrid between an accounting firm like us and somebody on staff, or they are in a space of, you know, it's all on the team because they're managing. They have to, especially in PI. It's your paralegal, your office manager. Somebody's got to manage that to make sure those are tagged correctly to every case. But, um, it's interesting because you brought up a good point, and I, I feel like this runs short of just the, the business owner mentality, just in a simple space of what lens are you, are you building financials for tax preparing moments? Are you building financials because you know that you're going to want a loan? You're going to want, um, you're going to want to grow, like you said. What are you building them to? You have to think through the whole lens, and it's not just one narrow scope. Just put them together and get them ready so I can file taxes. Okay, well, that's, that's an unserving—

Yeah.

That you're, you're— it's an oxymoron moment. You're saying you want to grow, but you don't have anything in place. To happen, or you're not listening to the advice.

I like that.

Yeah.

You would think the tax person would say, oh, wow, you've got a lot of expenses, and I don't see the advanced client costs on your balance sheet. But they don't. I mean, they're always at such a time crunch to do the tax return. I don't think that conversation happens a lot.

Well, and gone are the days where the tax preparer is going to spend a lot of time counseling the client. They're going to rely on the numbers that we provide them, and they have their disclaimer in their agreement with the client that they're not responsible. And so You know, it's on us to get it correct upfront.

It's really the— it's ultimately, it's the owner's responsibility no matter what. However, we are in a good place and with our knowledge and our base, and we are business owners ourselves. So as an accounting professional, as bookkeeping, all of that, just remember you are a business owner yourself. What they're handling, you're handling in a way personally. So through that lens, I look at it always like, how do I want this to work out? What would I feel like? And I love it when clients really engage us when, hey, I'm going to get a windfall here. Oh, okay.

I've got a case coming up and it's coming, right? And we've got a whole big— I got $1.5 million coming into the law firm shortly. I just want you to know that this is what's going to happen and prepare the staff so our staff knows that it's time to handle that too. And I think sometimes that's— it's nice that we have open lines of communication with our client, for sure.

Yes.

It means the world of being able to, for every person that's helping on that team, how to advise. Especially those conversations really need to be between a bunch of us. It's hard to absorb it the other way around. I can't fix your problem after the fact. Sorry, I don't have the magic wand today. It's just not happening.

Wait, you know, Magic Wand, I thought we had the investigators thing that we're kind of—

I know, right? Yeah, that's so true.

That's kind of our job too, right?

Well, I mean, going back to our episode where we— the episode on working with legal administrators, you know, if you set up that relationship with those people in-house, you'll get them to the point where they're going to be proactive and they're going to let you know, hey, we've got that $1.5 million settlement coming in in 3 weeks. And you can prepare yourself to help them get it all accounted for properly when it comes in. When you see it in the bank feed, maybe they didn't tell you it finally hit the bank yesterday or whatever, double-checking their settlement statements.

And there could be liens. So you're looking at talking to the record. There's things that might not really show that are on the books per se that we can pull from. We pull the reports, we pull the expenses, the advanced planning costs, we pull all those planning costs down, and then we give it to them and they have to really review that, which is why sometimes software like Casepear or Filevine are helpful for them to do that, to use those software when they're doing personal injury.

Yeah, but this is why I like LeanLaw, because I love the way it flows back and forth between the two. Oh my gosh, it makes it so simple.

I'm putting in a disclaimer. Please don't run out the door and just go start buying these products. Like, yeah, you're engaged with your accounting person because there is no one size fits all, folks. That's why sometimes I hold myself on mentioning products because I don't want you running out the door. This is an advisory space that you need to honor. Because it has huge impact in the wrong decisions.

I did, I did a, I did a meeting yesterday with some of the folks from Intuit on a project that they're working on. And I said, I never in a million years, if you told me back in 1999 when I started my business that I would be being an advisor on software, but our clients look to us. They know we're tech forward. They know where you get excited about these things that may automate some of the processes. And they come to us on this. This is another hat we're wearing that I never in a million years would have ever picked.

So it's so true.

But it's flattering too, right, Sarah? They come to us like, you know, we know this stuff. We bring it up in a conversation and we know their software, which is why it's so valuable to hire someone who is specialized in your industry that knows all this stuff because we stay on top of it. We get as excited as anybody else on the technology side of this.

What do we have? Let me just grab my little—

We call it shiny object system with squirrel. Oh, our squirrel.

Squirrel. I need a squirrel.

We gotta get you a squirrel. We gotta get you a squirrel.

I don't know what style mine is. It's in the gray category, but that's okay.

There it is. I got the brown one. We gotta get Steve a squirrel, Sarah. We gotta get him in the cool kids club with the squirrel.

This is a great topic.

This is a great topic, I think. Hopefully it opened the door to some questions, or it opened, you know, we would love to have some feedback on this. And I think that it's definitely a topic that can be One that attorney might be listening and saying, I don't think I'm doing this right. And then you can reach out to any of us or reach out. And I'm going to toss it to Sarah to take us away.

Yes, absolutely. Well, we absolutely love having these conversations, and we definitely need that subscribe button, if you would please, on our YouTube channel, on all the places. We enjoy this. We enjoy doing this, and we like to get some feedback. Please Share with us what it is that you want us to cover. I mean, at some point we might run out of ideas. We need audience participation, which is super enjoyable and it helps us keep us moving forward. We also have our mastermind group. So for those of you that are interested in that, it's called the Accountants Law Lab. You can visit us at our website at www.accountantslawlab.com if you'd like to sign up. Email us topic requests. Or I mean, you could do it on the different social medias. Throw out some suggestions in there. You can email us at info@accountantslawpod.com or on our website or on any of the social media platforms that we're on. And we would love it if you could follow us on Instagram. I guess we've added TikTok into the mix.

Sarah, you're just one social media machine right now. I can't keep up.

Well, it's for the, the happiness and the love that I have for my dear friend Tierra, who is helping me be that way.

I just, I crack up every time I see it. I know, right?

It's funny. You remind me of things, uh, when I need to go look at stuff, and I appreciate that too. Um, but yes, we, we would enjoy so much to keep this conversation going. We're, we're having it here, but we'd love the audience participation.

And join us in the lab. We'd love to have you.

Absolutely. For those of you that are in the accounting space, you're specific to an accountant that's working with law firms or wanting to work with law firms, that's the place for you.

So you get to mastermind with all 3 of us. So it's pretty cool.

It is cool. Yeah, definitely.

Okay, until next week, everybody.

Thank you.

Thank you.