<b>Any Answers:</b> UITF 40 adjustments: Who else has lost the plot? By Nichola Ross Martin

The Revenue's view is here: http://www.hmrc.gov.uk/helpsheets/ir238.pdf

Just because the REvenue say it doesn't necessarily mean it's right, of course, but it's as good a starting point as any.

Mike

The ICAEW have now commented on this here:

http://www.icaew.co.uk/index.cfm?route=135435

Part 1 and 3, read together, make a lot of sense, and confirm what most people have always said about UITF 40 - that the starting point is what is 'on the clock' at year end. It specifically answers the 'half-completed tax return' question (the one originally asked by Robert Maas) - you recognise half the income you expect in due course to receive.

Squaring this with what is said in Part 2, which is an annotated version of the ATT/AAT guidance is not entirely easy. We'll probably have a couple of articles on it over the next few weeks in Taxation.

Mike Truman
Editor, Taxation magazine.

The draft of IR238 is here, but I had to hunt a bit to find it.

http://www.hmrc.gov.uk/sa_drafts/pdfs/ir238.pdf

I think we need to focus more on what constitutes a "right to consideration".

I have come across (very occasionally) a firm's terms of business which say in effect "we earn our fees continuously and we can bill you continuously". A clause like that - properly drafted - would, it seems to me, grant a continuous right to fees, such that if you ever had to sue for fees on that basis, a court would grant your application without a murmur. Client relations are of course a separate matter .....

But in the absence of such a clause in the engagement letter / standard terms of business, what RIGHT is there to fees?

This is shading into a legal question and (usual disclaimer) I'm not a lawyer, but surely the default answer is that, when you've delivered the goods, you have a right to fees.

OK, we sometimes issue interim bills, and we're happy when the client pays them, but what RIGHT do we have to fees under those circumstances?

This situation, for me, has the feeling of a train wreck happening in slow motion. With effect from any minute now, HMRC are going to be expecting us to price all WIP at sales value, despite the fact that that is not what accounting standards say should happen. How do we stop this happening?

And what does ITTOIA 2005 s25 say? "The profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in calculating profits for income tax purposes."

I have the feeling this one will run and run.

You are making the common mistake of confusing 'right to consideration' with 'right to raise an invoice' the two are not the same.

I quote FRS 5 ANG directly:

"Right to consideration

A seller's right to the amount received or receivable in exchange for it's performance. This right does not necessarily correspond to amounts falling due in accordance with a schedule of stage payments which may be specified in a contractual arrangement. Whilst stage payments will often be timed to coincide with performance, they may not correspond exactly. Stage payments reflect only the agreed timing of payment, whereas a right to consideration arises through the seller's performance.

Performance

The fulfilment of the seller's contractual obligations to a customer through the supply of goods and services."

"Para G6

A seller may obtain a right to consideration when some, but not all, of its contractual obligations have been fulfulled. Where a seller has partially performed its contractual obligations, it recognises revenue to the extent that it has obtained the right to consideration through its performance"

What your engagement letter says is irrelevant (unless it says we won't bill you unless England win the world cup! Which of course is outside your control). You are earning your fee as you carry out the work, regardless of whether you can issue a legally enforcable invoice for them or not.

This is not an new concept by any means. Most people seem happy enough with SAAP9 and FRS5 ANG. UITF 40 is in essence mearly saying that these standards should be applied to contracts for services.

It is not the issue of a new standard, it is saying how the current standards should be applied in order to be consistant with GAAP.

Where are you getting the idea that valuing WIP at sales price is 'not what accounting standards say should happen'? Providing that the WIP relates to work that can be defined as a long term contract then this is precicely what the accounting standards say should happen.

Para G6 of AN G says "A seller may obtain the right to consideration...." It does not say "The seller OBTAINS a right to consideration...." In other words, I am not ENTITLED to be paid under the contract half my fee if I have only delivered half a tax return, unless my engagement letter says differently. Surely every client would agree with that.

I maintain my position, that it all depends on the terms of the contract, express and implied.

However, when the job is finished, I am entitled to be paid - even if I haven't issued the bill yet. At that point, the full sale value of the job should be reflected in WIP.

I have also looked back at SSAP 9. At the end of the day, we are talking here about contracts which SSAP 9 regards as long term, and para 22 of the Standard says "A contract that is required to be accounted for as long-term by this accounting standard will usually extend for a period exceeding one year."

In other words, the mere fact that a task is performed over a period which happens to straddle a year end does not mean that that task has to be accounted for as a long term contract.

I can't remember the last time I worked on something which took longer than 3 months to finish, never mind a year.

You appear to be doing selctive reading of SAAP 9. Para 22 actually says "[a long term contract is]where the time taken substantially to complete the contract is such that the contract falls into different accounting periods. [your quote]. However a duration exceeding one year is not an essential feature of a long term contract. Some contracts with a shorter duration than one year should be accounted for as long-term contacts if they are sufficiently material .... etc"

UITF 40 states that the combined effect of all contracts in progress at the year end should be considered when deciding if material, not on an individual contract basis. So it may well be that you don't have to account for the revenue on your WIP, but not for the reasons you are giving.

I'm afraid you are still missing the point about right to consideration. I repeat that it has nothing to do with the ability to invoice the work at the date you are accounting for. It is the fact that you can be reasonably certain that you will be able to invoice the work at some point in the future. For many, many years this has been standard practice in accounting for building contractors etc where an asset is being contructed. If such a company has a December year end and stage payments are agreed for November and January then the customer would quite rightly never pay an invoice issued in December. However you would recognise the income attributable to work caried out in December, surely you agree with that? It is exactly the same concept being applied here.

Using your half completed tax return as an example. When you bill the final completed return, the work you undertook to get it to the half way stage at your year end will form part of that invoice. Therefore you have a right to consideration at the halfway stage. You do not necessarily have a right to raise an invoice and get the money at that point as this is something that is decided between you and your client.

As FRS 5 says in the paragraph I quoted before, the right to consideration does not necessarily correspond with any agreed stage payment (which may just be a final invoice).

You are quite right that FRS 5 ANG para G6 says that you may obtain consideration, not will obtain. However as is clear from the standards the entitlement to be paid at that point in time is not a factor in deciding if you do have a right to consideration.

What you have to think about is what is being taken into account at the end of 2005 as well. Assume they have another report on the go at that time, and are also halfway through it. This time she is expecting £50,000 for the report. That means that £25,000 has to be brought in as income for 2005 in addition to what has already been billed.

Look at it another way - assume that Anita and her assistant each work 1500 chargeable hours a year. In previous years they have more or less brought into account 1500 hours a year. But for 2005 they have to bring into account the 1500 hours they work in 2005 PLUS the 100 each that they did in 2004 on the project billed in 2005. That's why it gets a spreading relief.

Mike Truman

I am afraid I have become increasingly confused throughout the UITF 40 saga.

I understood it was intended to clarify the treatment of certain "continuous" services, where unbilled amounts had to be included in turnover for the year. It does not (I understood) apply to items billed on a "per project" basis.

So how would it apply to a report? Surely half a report would not normally be a billable item?

Richard

Just because half the hours envisaged for the report preparation have been used up, and half the work has indeed been done, that does not mean that Anita necessarily has a right to half the fee for it. You have to look at the terms of the contract to know whether she can claim 50% at that point or not. So the Revenue example simply doesn't contain enough information.

As para 27 UITF 40 reminds us, "Where the substance of a contract is that a right to consideration does not arise until the occurrence of a critical event, revenue is not recognised until that event occurs."

It might be that Anita has no right to anything until she has delivered the final report, in which case the WIP is merely her assistant's time at cost. Or Anita might have already delivered an "Initial Comments" document and spent some time on the final version. If she is entitled to a stated part of the fee for the initial document, but has not billed it at the year end, then her WIP will be that initial fee, plus her assistant's time to date (at cost) spent on the final document.

Our firm's year end is 30th April, and I am currently wrestling with what closing WIP will be in the 2006 accounts. It certainly won't be the sales value of everything on the ledger, because plenty of jobs will be at a stage well short of when they can be billed. Equally, it won't be the time costs shown on the ledger, because some things WILL be billable at that point, and some time will - as every year - never be billable.

The best I can come up with so far is to bill every last thing we possibly can on 30th April, keep the rest at cost and provide against older time as before.

None of which helps with the opening adjustment at 1st May 2005, when we were not being quite so rigorous...

Has anyone actually had the last word on UITF40? I thought this was all settled such that all wip had to be treated as accruing fees (except for contingency fees)and I received some excellent guidance on this from ACCA - and then the AAT/ATT issued contradictory guidance. What I want to know is that for a small accountancy practice like mine, do I value wip at cost as before or do I accrue for it all as unbilled fees? In particular for assignments such as a half completed accounts prep job.

I am in same position as Jon.Seems a simple question to ask but I am confused as to the correct treatment.

As an additional quesstion how does the rule appy to ,for example,subcontactors,garages,and other businesses that have WIP each year end that includes labour costs and in some cases material costs?

I also read somewhere that if UTIF 40 adjustment increases the profit that no Class 4 NIC is due as it is Sch 4 Case VI . Is this correct?

To Richard

UITF 40 states in paragraph 12 that sevices provided on an ongoing basis rather than a single service should not be accounted for as LTCs. In paragraph 13 it states that contracts for services that constitutes a single service which falls into more than 1 accounting period should be accounted for as a LTC. So you have it the wrong way round.

To Brian

You need to look at paragraph 19 as well as 27 which states that this only applies where the right to consideration is conditional or contingent on an event or outcome outside the sellers control. This is refering to things such as no win no fee engagements for solicitors. It's extremely unlikely that this could be applied to any work an accountant would do. You'd have to assume it's entirley within your control to finish the report.

Application note G para 3 states that a right to consideration arises through the seller's performance. It is not determined by the right to invoice.

I would really like an authoritative answer on UITF40, i.e. whether as a small accountancy practice I should be valuing WIP as a debtor, e.g. half completed tax return, whether this is to be valued at half x ultimate fee or at cost still. I don't mind what the answer is, just want clarity.

However there is also the practical issue of valuation, especially as you can have several hundred clients with WIP. You can't pontificate on each one. Practical problems...

1. value accruing in the job is not necessarily linear to time spent. This being the case how else does one measure it?

2. I have WIP on the clock for some clients that may not be billed for another year, so I don't know how much profit I will make, and so do not know how much to apportion.

3. Many clients have the odd 50 pounds of WIP on the clock from the odd phone call or letter. Their eventual bill is say 750 when the accounts are done. Should we value this 50 at nil on the basis that the job is in such early stages that it is inapporopriate to recognise revenue? If so do we instead value this 50 at cost?

4. I have 100 in WIP. A further 1,000 is spent in completing the job. I bill the client 800 and thus make a loss of 300. Which is the time of 300 that I have written off. Was it the first 300, the last 300 or should I average it?

5. It is tempting to value the whole WIP for the practice at total WIP x average practice recovery rate. This is a blunt approach and ignores the fact that WIP still on the clock is more likely to have a higher irrecoverable element.

6. Some practices do not keep time sheets. What on earth will they do?

Part 1 para 7 b i says:

"So in a simple case, where a contract is for £10,000 and it is half performed at a year end, the seller should recognise revenue of £5,000."

Para 5 concludes: "But references to ‘milestones’should not be read as a way of defaulting to completed contract accounting."

Para 11 summarises the effect as: "In summary, UITF 40 applies the principles of AN G to service contracts and in doing so brings service contract accounting onto a similar basis to contracts for the supply of goods and services as set out in SSAP 9. Where service contracts have not been accounted for on this basis, UITF 40 does introduce a change (normally an acceleration) in the timing of recognising revenue."

In part 3, question 3, the sentence immediately before the one you quote reads: "The only circumstance under which it would not be appropriate for John to recognise any revenue would be if his right to consideration was contingent on a specific trigger event, the outcome of which he cannot control (as outlined in UITF 40.19)."

I agree that there may be situations where a simple comparison of time worked so far to total time expected to be worked may not be appropriate - compliance work might arguably be less valuable than consultancy work for example - but the guidance makes it blindingly obvious that it is the value of the work performed AS PART OF THE COMPLETED PROJECT that is being considered, not its incomplete value: see the whole answer to Q3 again.

Part 2 is not actually a direct copy, but looking at it further I agree that little of significance is changed. This raises the issue of why the ICAEW has issued guidance in parts 1 and 3 which does not tie up with what is included in Part 2, on which I couldn't possibly comment (though the heading to that section may contain a clue...). But to pretend that this is simply an acceptance of what the ATT put out is whistling in the wind; the very specific guidance in parts 1 and 3 about part-completed contracts make that clear.

Mike Truman