What's New?

Work in Progress - UITF 40 could prove costly

UITF40 (May 2006)

In the main businesses currently providing services account for revenue on completion of a contract, unless they bill on account as the work progresses. Any costs associated with incomplete work are carried forward as work in progress. Sole trader and equity partner time is ignored when valuing the costs of work in progress.

So what has changed?

Under UITF 40 it will be necessary to account for revenue as a contract progresses, irrespective of completion date and billing date. Put simply, if the work on a contract is 50% complete then, at the year end, the business must recognise 50% of the expected recoverable amount. Work in progress, valued at cost, is effectively being replaced by accrued income valued at selling price.

Will the new rules apply to all contracts?

Most contracts for specific services, but there are some exceptions.

It will not be necessary to adopt the change if the right to a fee is conditional upon any external event outside the control of the provider. An example of such an excluded service would be that of an estate agency where any fee is normally contingent upon the sale completing. There are also some other exceptions where the contract does not provide for a single service, or a number of services comprising a single project. (UITF40 quotes examples of repetitive services such as general professional advice, accounting support and help-desk support but it is not expected that this exception will provide an escape for most professional businesses).

So why will more tax become payable?

Tax must be paid on accounts that show a true and fair view. This is achieved by following generally accepted accounting principals (GAAPS) and this means accounting standards and guidelines issued by the Accounting Standards Board (ASB).

UITF 40 represents an accounting standard issued as a response to great confusion caused by the issue of an earlier statement from the ASB � Application Note G, part of Financial Reporting Standard 5(FRS5)

The new rules will replace previous guidelines and, where the change creates an increase in the amount of profit to be recognised at the date of change, this creates an additional liability to tax on the amount of that increase.

When does the change take effect?

For most, the accounting period ended after 22 June 2005, but it will be necessary to calculate what the work in progress/accrued income position would be under the new rules at the previous year end.

Example

Mr Fiddler is a solicitor with two employed fee earners and a small level of support staff. Most of his work arises from probate and matrimonial work. His year-end is 31 March and at 31 March 2005 the position regarding uninvoiced incomplete work is as follows:

Old Rules

Work in Progress: Employee fee earner time (at cost)

�20,000

New Rules

Value at charge-out rates

Estimated recovery rate

Value of accrued income:

The difference is taxable!

Difference

Income Tax @ 40% payable on 1 January 2007

�140,000

90%

�126,000

�106,000

�42,400

What should you be doing?

� Consider the extent that your business will be affected, including which work and which contracts

� Establish the magnitude of the potential tax burden and take steps to ensure funds will be available to meet this.

� Consider billing routines and contract terms

� Establish procedures for measuring the value of accrued income.