Relatively early in a law firm’s existence, a decision is required concerning whether to report financial activities to the Internal Revenue Service on a “cash” or “accrual” accounting basis. Irrespective of the choice made for this important tax election, it is vitally important that firm leaders have a solid understanding of the differences between the underlying methods and that each be given equal weight in administering the financial affairs of the firm.
Under the accrual method of accounting, law firms generally recognize income for tax purposes when invoices for services rendered are mailed to the client. Law firms will usually recognize expenses when invoices from vendors are received. Under the cash method of accounting, law firms generally recognize income when a client’s remittance is received, and expenses when payments to vendors are actually disbursed. There are, of course, numerous exceptions to these broad rules.
