To Defer or Not to Defer - Website Hosting Income

To Defer or Not to Defer - Website Hosting Income

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A new client has a web design business.  As part of this, in common with many such businesses, they host clients' websites and email accounts manage domain names.  Rather than charging monthly fees for this they will charge for a year up front for hosting and two years for domain names (as they tend to renew them for two years).

Year end is November.  I would have thought that if they charged someone on 1 Nov 2013 for a year's email and website hosting (i.e.: period 1 Nov 13 to 31 Oct 14) we should be deferring 11/12 of the income into the following accounting period.  I'm only doubting myself as the previous accounts do not include a deferred income balance.

Once added together for the full year the deferred income balance is actually reasonably material.

I'd be greatful if someone could confirm I'm not going mad and we really should be deferring this income into future accounting periods.  Obviously if we are going to defer the income we would need to prepay any costs paid up front to the hosting company and domain registrar.

Thanks in advance

Replies (9)

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Stepurhan
By stepurhan
18th Feb 2014 15:23

Consistency

You are correct in a way. However, you may find that there is a reason that this has not been done before.

This is essentially a practical one. Presumably this business has been going for a while. Therefore the person you are billing at 1/11/2013 will have been billed on 1/11/2012 as well. Assuming fairly stable pricing, accounting for the whole of the bill at 1/11/2013, and accounting for the proportion of the bills on 1/11/2013 and 1/11/2012 will lead to more or less the same result. If the customer base is also stable then the same will be true for the business as a whole. Not entirely unlikely if they have a set amount of hosting capacity, so new clients are only brought in when old clients leave and free up space.

So you are looking at a complex calculation (because you would have to do it at least for every month, if not every customer) for what is probably an immaterial difference. Add to that the complication of trying to move from not providing for it to providing for it, and it is probably not worth doing.

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By The Limey
19th Feb 2014 09:28

It may be the same from year to year on a profit or loss basis, but it certainly won't be the case with respect to the balance sheet. In particular, it won't be the same for distributable earnings.

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Stepurhan
By stepurhan
19th Feb 2014 09:41

For what reason

If it is the same for profit and loss purposes, it will be the same for distributable earnings. Those are the same thing.

It will also be the same for the balance sheet total going forward if the deferred income figure is steady year on year. I have given the reasons why this is likely to be the case in my first post. In fact, since you are acknowledging that the profit and loss will be the same then the balance sheet has to be the same, subject to share movements. That is how balance sheets balance.

The only time the balance sheet would be affected is in trying to move from one to the other. Therein lies the problem, because shifting from one to the other is likely to be a major change of accounting policy. Either the current year figures will be enormously distorted (no longer true and fair?) or you at looking at adjusting the prior year as well. 

So, excepting the change-over period, please clarify why you think the balance sheet would change.

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By The Limey
19th Feb 2014 09:46

No, it's only the same for profit or loss from year to year (year a versus year b). It is not the same for accumulated profit to date.

Because the deferred income is a credit to the balance sheet (no mention was made of any accrued income) deferring income will reduce net assets.

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Stepurhan
By stepurhan
19th Feb 2014 10:40

Take your point

I see what you mean now, the accumulated distributable earnings would be different, not the year on year figure.

I'd still largely be against the change. The main reason is that any difference in distributable earnings would be historical. Changing it now would be a major change of the existing accounting policy (to recognise all income at the start of the year). That is not something you do lightly. The accounts figures for the current year would be distorted, so you are looking at a prior year adjustment. The weird results will also possibly attract HMRC attention. If you are saying that this is how the income should be treated all along, are you opening up all prior year returns to enquiry as demonstrably wrong? The deferred income would also be partly matched by accrued costs (which were mentioned in the OP) so there will be some offset, though there will still be an overall movement on the balance sheet.

Of course, the whole thing might be moot anyway, because we haven't checked one vital fact. What do the terms of the contract say? If the customer is locked in for 12 months regardless, then it is correct to show all the income now anyway. You'd only defer the income if there was potential for it not being received.

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By The Limey
19th Feb 2014 14:58

No, even if the customer is locked in for 12 months it is not correct to recognise all revenue at once (service has yet to be performed). From a tax perspective it's similar to UITF 41.

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Stepurhan
By stepurhan
19th Feb 2014 15:12

Are you sure?

Perhaps locked in was a bad choice of words. I meant that the whole amount is due, regardless of whether the customer ceases to use their website and e-mail or not. If the company has an irrevocable right to the income now, without a similarly irrevocable obligation to provide a service, it should be recognised now.

UITF 41 is scope of FRS 20 (share based payments). Not wanting to wade through the whole thing, could you point me towards the part you see as relevant please.

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By The Limey
20th Feb 2014 09:42

Oops. Sorry - UITF 40...

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Stepurhan
By stepurhan
20th Feb 2014 10:56

That makes more sense

Yep, that makes much more sense. I was afraid I was missing something on the application of share based payments. :-)

That is indeed appropriate to the situation, but I'd probably be prepared to argue against it having force in this case for a couple of reasons.

UITFs, while good practice, only really have force for large companies. I would be surprised if the company in question was not eligible for the FRSSE. Strict compliance with all standards is not required for FRSSE companies.Does the company have right to all of the consideration up-front anyway? If so then recognise all now. If not, then deferring may be appropriate (though not necessarily required). This would depend on whether the customers could get anything back if the contract terminates either way before the year is up. If the company gets the full year's money regardless, then the obligation to provide the service is moot. It only matters if they HAVE to provide the service in order to get the money.

As an aside the focus of UITF 40 is the opposite direction. (when you must bring income in, not when you leave it out). All the wording is therefore focused in the opposite direction. Whilst I'm not disputing the principle, I'm just curious how simply reversing the provisions, as we are doing for this example, would be viewed if a dispute were to arise.

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