Attorney Bookkeeping: Direct or Hard Costs

I know I have written many articles on this topic. But it seems to be the one topic that keeps attorneys and bookkeepers awake at night. Let's dive in.

Hard Costs/Direct Costs Definition:

They are fees that the law firm pays on behalf of a client. The attorney may already have received a retainer for this client, or he or she may not. Hard costs/direct costs are for the fees paid directly for a client as a fee in the case or matter.  It is always paid out of the operating bank account.

How do you book this into the Accounting Software?

You create an asset account called "Advance Client Costs or Client Advanced Costs."  You use that item or category in the transactions. For example, you paid a witness fee on behalf of your client.  You do not book this as "professional fees." You book this to the Advance Client Costs account.

When is a direct fee not an Advance Client Cost?

If the attorney pays the fees for a client or matter (direct costs) but he or she pays them out of the IOLTA or trust bank account, they are not  Advance Client Costs.

It is not an Advanced Client Cost because if the attorney paid out of IOLTA, the attorney used the client's funds to pay for the client's matter expenses. The law firm did front these costs.

So how do you book that into the Accounting Software?

That's simple. Try to think of any retainers held as little mini checkbooks for that client that you are maintaining the books. That's the best way to wrap your brain around working with law firm clients.

If an attorney uses that money held in the retainer to pay an upfront cost, the client is, in essence, paying for their own fees. You would book the fees as a payment straight out of that client's ledger account. There is no need to categorize it as it has nothing to do with the law firm's money. Those fees never hit the law firm's profit and loss report as a billable expense.

Below are a few use cases, so you can see how to manage this is essential account.

Scenario #1 Advanced Client Cost Method

Let's imagine that Allison Attorney has received a retainer of  $5000 from her client. She put some money into her trust bank account and created a liability account for her client's funds (aka the mini ledger). That's the offset. Now she's had to pay for a $400 filing fee on behalf of her client. That money is spent out of her operating account, and she did not use the trust fund account. In this case, The fees get booked to the advanced client's cost account. That account is an asset account. It will only show on the balance sheet. Think of it as a clearing Account.

Now Allison Attorney starts to generate some of her time working on the case or matter. It's now time to bill the client for the fees that she spent her firms' money on and the hours that she's accumulated working on this case. When Allison bills her hours, they get booked to legal income. When she bills back that filing fee, she uses the same item initially used in the transaction, which was the advanced client cost account. Yes, the same account is used when you spent the money out of the operating bank account. The term I'm not particularly fond of using  but is compelling here is "money and money out." At no time does it affect the profit or expense lines in QuickBooks for Allison Attorney's books.

Scenario #2 Billable Expense Income/Billable Expenses Method

Let's say you inherited a set of books that the law firm booked all expenses into a billable expense account. They are not using the advanced client cost method at all. How do you handle that?

When I see books set up this way, it's not wrong. In fact,, they are probably using the billable expense/ billable expense income account method. So again, it's "money and money out," but instead of an asset account on the balance sheet, it is an account on the income side and the expense side. It's still net zero in a client's file.

Scenario #3 is the Client Cost Account Reconciled?

What if have you have inherited a set of books where a client put things in the advanced client cost account but never reconciled the account? How do you know where to begin to fix this?  Reconciliation is an essential step in this accounting workflow, but unfortunately, reconciliation never happened. 

Cleaning up the Advanced Client Cost account is where you will have to work closely with the law firm and the attorneys. You are going to need to know what should still be sitting inside of Advanced Client Cost. You need to know what should be left behind waiting to be billed in the future. If this process never happened, it will take a bit of investigation and work on your side to complete and ensure that the remaining items are correct. What's left behind should be your work-in-process items.

Scenario #4 What happens if these client costs are not invoiced back to the client?

There are times when you have to move things out of the Advanced Client Cost account if they'll never be invoiced back to the client. When that occurs, it becomes an expense for the firm.

An example of this would be working for a personal injury attorney who bills on contingency. They may take on a case or a matter and upfront a lot of the client direct costs. Sometimes the attorney will take a retainer from their client to cover some of the fees.   But what if the attorney doesn't win the case? And then some of those fees were paid by the law firm?

When that happens, there needs to be an entry to move expenses out of the Advanced Client Cost account and move it to "Billable Expenses Incurred but not Recovered Account." Now this affects the attorney's books as an expense to the firm.

As you can see from the above scenarios, accounting for an attorney's books can be complex. The bookkeeper will need to wear the investigative hat, and you need to work closely with the attorney to fine-tune what is in this asset account, for example, what should be in there and what should not. Thus, it is essential to hire an expert who knows how to work with law firm books.  I don't want to put in capturing any expenses that belong on the law firm's books.

 Are you an attorney who has books that are not exactly the way they should be?

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Lynda Artesani

Lynda Artesani is the president of Artesani Accounting. Her firm specializes in working exclusively with the legal industry. She is passionate about helping her attorney clients migrate to modern cloud-based systems and become future-ready.​ ​ She is a Top 100 ProAdvisor, an alumni member of the Intuit Advisory Board and a member of the Intuit Trainer Writer Network. She also runs a Facebook group and a private group called The Accountant's Law Lab. It is a place where members can learn how to work with attorneys and law firms. Lynda lives in Southwest Florida. She is a registered yoga teacher and in her free time, you will find practicing yoga or walking on the beach.​