Revenue Recognition for Cash-Based Accounting
In cash-based accounting, revenue is recognized only when payment is received for work performed. For law firms, this means that income is not recorded when an invoice is issued, but rather when a client’s payment is applied to that invoice.
Payments made by clients—such as retainers—are initially held in a Trust account. When funds are transferred from trust to the firm’s operating account, they are recorded as Deferred Revenue. Once a payment is applied to an outstanding invoice, the deferred revenue is recategorized as Income, with the classification for every dollar determined by the invoice line items (for example, fee income, miscellaneous income).
This approach ensures that revenue is accurately recognized only when it is earned and received, providing a clear and compliant financial picture of the firm’s operations.
Invoice Line Items
Invoice line items categorize the income when a payment is applied to the invoice.
Time Entries
Items specified on time entries will define the income classification based upon the chart of account associated with the Item. By default, all Items are associated with the Fee Income chart of account but you can update the Item to select a different account, if needed, to match your firm's accounting practices.
Time entries without an Item will be classified as Fee Income.
Click here for more information on updating an Item's chart of account.
Flat Fees
Items specified on flat fees will define the income classification based upon the chart of account associated with the Item. By default, all Items are associated with the Fee Income chart of account but you can update the Item to select a different account, if needed, to match your firm's accounting practices.
Flat fees without an Item will be classified as Fee Income.
Click here for more information on updating an Item's chart of account.
Expenses
Categories specified on expenses will define the income classification based upon the chart of account associated with the Category. By default, all Categories are associated with the Miscellaneous Income chart of account but you can update the Category to select a different account, if needed, to match your firm's accounting practices.
Expenses without a Category will be classified as Miscellaneous Income.
Click here for more information on updating a Category's chart of account.
Interest
Interest line items will be categorized with the Interest income chart of account.
Tax
Tax line items will be categorized with the Sales Tax Liability chart of account.
Payment Applications
Payments applied to outstanding invoices will automatically generate journal entries to recognize the revenue and recategorize the payment from Deferred Revenue to the applicable Income accounts, as driven by the invoice line items.
Journal entries will be summarized and totaled by each chart of account across all invoice line items. For example, an invoice with multiple time entries that have items all associated with the Fee Income account will create one journal entry line for Fee Income.
Each unique payment application to an invoice will generate an individual journal entry. If one payment is applied to three invoices, as an example, three journal entries will be created for each payment/invoice combination.
These journal entries can be viewed through the individual Chart of Account ledgers.
To view a journal entry created from a payment application follow the steps below:
Navigate to Accounting > Chart of Accounts.
Select the Chart of Account you wish to view (e.g. Fee Income).
This opens the ledger for the selected Account.
For payment application journal entries, the Description will provide audit details for the journal entry. The payment and invoice numbers will be included for easy reference and traceability.
Click on a specific row to view the Journal Entry. Typically these payment application journal entries will Debit Deferred Revenue and Credit the income accounts associated with the line items on the invoice.
Note: Journal entries created as a result of payment applications are not editable.
Applying Payments 'Expenses First'
When applying payments to invoices, journal entries are created using an 'Expenses first' approach. This means that, for partially paid invoices, funds are applied to expense line items (representing costs incurred on behalf of the client), before being allocated to other line items such as legal fees.
This method ensures that your accounting accurately reflects the recoupment of client-related expenses before recognizing fee income, aligning with common law firm practices.
Unapplying Payments
When unapplying a payment from an invoice a new journal entry will be added to reverse the initial journal entry created by the original payment application. This journal entry will be dated with the date the payment was unapplied. This ensures an accurate timeline and history is retained.
Onboarding Operating Accounting
During onboarding of your Operating Accounts, your firm's starting balances for these chart of accounts will be prefilled based on your firm's data in PracticePanther. Using your historical payments and payment applications in PracticePanther, the starting balances for the following chart of accounts will be populated during Step 3, Enter Starting Balances, of the onboarding process.
Deferred Revenue
Fee Income
Miscellaneous Income
Interest Income
Client Cost Advance
Sales Tax Liability
