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Valuing developers WIP

Valuing developers WIP

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Simple example. Property developer building one house which is sold just after year end with majority of costs in first year.

Should Work In Progress merely be at "lower of cost or NRV", or including overhead allocation or should attributed profits be included  ?

If profits should be included on what basis ? Time, Pro-rata to build costs? 

Note no actual stage valuations were carried out.  

If WIP is on lower of cost or NRV then a loss will be made in the first year and all the profits in the second year so does this really present a "true and fair view" ?

Any comments welcome.

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By Towards excellence
24th Jun 2010 09:38

Cost + attributable profit

My recollection is that you need to follow SSAP 9, and include an estimate of the profit element.

This principle also applies to professionals like solicitors and accountants, as stipulated by UITF 40.

SA

 

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By WhichTyler
24th Jun 2010 09:49

SSAP9

You shouldn't include an element of profit unless the contract to sell was in place at year end (assuming the developer is doing the work speculatively). You would include it if they were the contractor doing the work for a client, and the costs to completion could be reliably estimated. In short the profit arises on sale, not before

Previously discussed here:

https://www.accountingweb.co.uk/anyanswers/what-profit

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By TTID
24th Jun 2010 12:57

SSAP 9 & UITF40

SSAP 9 might state that lower of cost or NRV but surely UITF 40 replaces this.

Therefore in considering UITF40

1) The revenue should not be recognised as the right to consideration does not occur unitl the occurence of a critical event ie the sale of the property.

However

2) the transaction is performed over more than one accounting period

3) the prudentially calculated profit can be assessed with reasonable certainty as we know the selling price for the property.

So does this mean Work In Progress should be shown including prudentially calculated profit but that this amount is not to be included as debtors & turnover.

 

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By WhichTyler
24th Jun 2010 13:07

Why UITF40?

This isn't a long-term contract. The contract only occurs when the property is sold.

If a builder has a contract to build a house, and the contract covers various accounting periods, they should account for some profit at the end of each AP, as the contract is already in place. But that's not what is happening here.

If you have a shop, you may well know the selling price of the stock you hold at year end, and you may well sell it for that price after year end, but you don't anticipate the profit as the sale hasn't happened by the year end.

 

 

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By TTID
24th Jun 2010 13:45

So to sum up...

So to sum up the position:

Two builders could build a house in the year to 31/3/2010 at a cost of £100,000 with a sale of £200,000 on 1 April 2010.

Builder A who contracted with an individual to build a house for £200,000 will account for £100,000 profit in p/e 31/3/2010 under UITF40 for revenue recognition showing £200,000 as turnover.

 

Builder B who built speculatively and then sold will account for £100,000 profit in p/e 31/3/2011. The p/e 31/3/2010 having all costs carried forward as WIP but no profit.

 

 

 

 

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By WhichTyler
24th Jun 2010 14:14

Nearly there

 

Two builders could build a house in the year to 31/3/2010 at a cost of £100,000 with a sale of £200,000 on 1 April 2010.

Builder A who contracted with an individual to build a house for £200,000 will account for £100,000 profit in p/e 31/3/2010 under UITF40 for revenue recognition showing £200,000 as turnover.

Builder B who built speculatively and then sold will account for £100,000 profit in p/e 31/3/2011. The p/e 31/3/2010 having all costs carried forward as WIP but no profit.

In the first example, the sale happens when the Builder signs the contract to build the house, so by 31.3.10 he has fulfilled his obligations and is just waiting to be paid (if he hasn't been paid along the way). The important thing is that the contract is in place before 31.3.10. The builder is acting as contractor, so-called because he is working to a contract. As it is a long term contract for service (the service of building a house), UITF 40 applies (And if he is halfway through building by 31.3.10, you start apportioning based on valuations to date, cost to completion, etc).

In the second case the sale happens after 31.3.10, so at the balance sheet date there is no obligation for anyone to pay him anything, so no profit to accrue. The contract is for transfer of ownership, not a long-term contract for services, so UITF40 does not apply. So he's not a contractor, but a developer, taking the risk that the house may not sell. You can disclose as a post balance sheet event if it's material.

 So your example is right in principle, but the terminology is a bit woolly

Hope this makes sense

 

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By Chris Smail
24th Jun 2010 14:23

Thats right

Contract > UITF40

No Contract > SSAP9

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By TTID
25th Jun 2010 08:58

So for the sake of clarity..

Thanks for all the comments and so for the sake of clarity, in simple terms:

UITF40 covers "contract" WIP and this will be included as Debtors & Turnover with appropriate profit

and SSAP9 will cover non-contract WIP and this will be at lower of cost & NRV.

 

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By WhichTyler
25th Jun 2010 10:22

Check

Current assets rather than debtors, I suspect but otherwise fine

 

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