Indirect or Soft Costs
A couple of weeks ago, I wrote an article that was all about Direct/Hard costs when working with attorney clients. This week we are going to dive into what Indirect/Soft costs are.
These expenses are fees that are law firm overhead and are expenses that are sometimes allocated to clients or matters. Often, these costs are applied to multiple matters, not just one specific one, which makes it challenging to determine which part of the fee belongs to which client.
A few quick examples of indirect/soft costs for law firms are things like:
You will probably not count every stamp or piece of paper or portion of toner for a client. There are a few methods to capture these expenses to bill them back to the client. Asking about these fees is important and something you want to discuss with your attorney-client if you're starting an engagement.
Many times my new client's life cycle starts with a data migration project moving a law firm over from desktop software that's not working. An integral part of onboarding a new law firm client into cloud-based software like LeanLaw is asking the attorneys questions around invoicing. One of the questions is:
"How do you handle the indirect costs and direct costs?"
Soft Cost Entries in LeanLaw
Fortunately, with LeanLaw, capturing and charging back for an indirect cost is very simple. As you can see below, I've demonstrated the simple steps. Don't forget to add the details in the invoice description line as that is what will port over to the client invoice at the time of billing.
Some attorneys choose to charge an administrative fee that will capture all of these expenses. It's usually a flat amount for a particular percentage. That makes our life easier when calculating these expenses. If you use law firm time and billing software, LeanLaw, it's a feature in settings that are built right into the software. Typically an administrative fee is part of a contract or agreement that the law firm will have with the client.
Expense Categorization/Income Recapture
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.
Billable Expense Income/Billable Expenses Method
Any soft costs should be booked in as the expense that you are paying. If you need stamps for postage, book this as a postage expense. Paper? Office supplies. When invoicing for any postage used on a client matter, they get booked as "expenses" billed to the client. But as you bill them, they are booked to billable expense income.
Credit: Bank account
Debit: AR (invoice transaction)
Credit: Billable Expense income
Increase your hourly rate
This strategy is sometimes an avenue that attorneys will choose to increase their fees to include the soft costs recapture overall. Why? Because re-billing soft costs are sometimes is what a client will complain about on their bill. All those line-item expenses on their invoice can be irritating to the law firm client. Often, the attorney will write them off or write them down to keep a happy client-attorney relationship.
New Client Tips:
Depending on your law firm software, you should review this expenses section to ensure that you don't have anything hanging up there and work in process (WIP) that will never be billed. Like hard/direct costs, It's essential for clean books to have and a proper work-in-process.
If you are an attorney and are looking for someone to do your accounting work, you found the right place! Give us a call, and we love to help you.