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Revenue recognition in legal services can be difficult. Unlike product sales, legal engagements are long, unpredictable, and based on subjective outcomes. Here’s a breakdown of the most common issues law firms face when trying to recognize revenue accurately.
Many legal cases span months or years. Since revenue should be recognized when value is delivered to the client, it’s often unclear when that moment occurs. This creates inconsistency in financial reporting.
Contingent fee cases only result in payment if the firm wins or reaches a favorable settlement. Until that happens, the revenue is uncertain and cannot be recognized—even if a significant amount of work has already been completed.
Law firms often use multiple billing models, including:
– Hourly Billing: Easier to track but still requires performance tracking.
– Flat Fees: Must be spread over the engagement unless the value is delivered upfront.
– Retainers: These are not revenue upon receipt. They must be recorded as deferred revenue until services are provided.
Legal services don’t always have clearly defined deliverables. This makes it hard to apply the percentage-of-completion method. Court delays and ongoing case work make progress subjective.
Clients often have the right to cancel service at any time. If services haven’t been fully performed, unearned fees may need to be refunded. This complicates the timing and certainty of revenue recognition.
Under ASC 606, law firms must:
– Identify the contract
– Define performance obligations
– Determine the transaction price
– Allocate the price to each obligation
– Recognize revenue as obligations are fulfilled
Reference: Revenue Recognition Summary – FASB
Law firms must also follow state bar rules and ethics guidelines. Recognizing unearned revenue too early can lead to ethical violations, especially when handling retainers and client trust accounts.
Revenue recognition for legal services is complex but manageable. Firms must align with accounting standards like ASC 606 while also following ethical rules set by their state bar. Accurate revenue tracking improves compliance, decision-making, and investor confidence.
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