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I ADMIT IT! OK, I was wrong. Well, perhaps that is a bit of an exaggeration. I still think that my interpretation of UITF 40 as set out in my articles of
2 May 2005 and 23 June 2005 is the one that most logically ties in with Application Note G to FRS 5 (see 'Glossary and links' ). However, I do now accept that the interpretation adopted by the ICAEW in its FAQ reflects the intention of both the ASB and the UITF. The ICAEW has now issued further, more detailed guidance which includes a number of helpful examples.
Has UITF 40 changed the UK accounting world in relation to services? Yes, very much so. Has it abolished work-in-progress (WIP)? Not wholly, but it has very much restricted the circumstances in which WIP will arise.
The purpose of UITF 40
How did I fall into error? Well I saw UITF 40 as an explanation of ANG and accordingly interpreted terms used in it in accordance with the definitions in the application note. In particular, the phrase 'right to consideration' seems to be defined in ANG in terms of a contractual entitlement. It looked at the rights received in exchange for performance and defined 'performance' as 'the fulfilment of the seller's contractual obligations'. UITF 40 uses 'right to consideration' to mean a realistic expectation that the work done to date will generate a predictable amount of consideration. Indeed ANG is largely (but not wholly) a red herring. What UITF 40 does is to clarify the meaning of SSAP 9, which most of us have been misinterpreting since 1975 by limiting its application in relation to long-term contracts largely to construction contracts.
Paragraph 20 of SSAP 9 defines a long-term contract as including 'a contract entered into for ... the provision of a service ... where the time taken substantially to complete the contract is such that the contract actively falls into different accounting periods...'. Accordingly, a contract that extends over a mere two days can be a long-term contract under SSAP 9. And paragraph 29 of SSAP 9 requires that 'where it is considered that the outcome of a long-term contract can be assessed with reasonable certainty before its conclusion, the prudently calculated attributable profit should be recognised in the profit and loss account as the difference between the reported turnover and related costs for that contract'. In effect, UITF 40 gives further guidance on how to calculate the 'reported turnover'; i.e. the turnover to be included in the profit and loss account in respect of the contract. It also makes clear that although paragraph 29 refers to a contract by contract basis, paragraph 22, which permits contracts lasting less than a year not to be treated as long-term if the effect is not material, does not do so. Accordingly, materiality needs to be approached by looking at all under twelve-month long-term contracts as a whole.
The requirement in paragraph 26 of UITF 40, to recognise income as contract activity progresses to reflect the seller's partial performance of its contractual obligations where the substance of the contract is that the seller's contractual activities are performed gradually over time, looks back to paragraph 20 of SSAP 9.
The new guidance
What the new ICAEW guidance makes clear is that although in many cases spreading the income on a time basis will be the easiest and most appropriate way to arrive at the income this will not necessarily be the case. Circumstances are not always that simple and judgments will be required to determine the appropriate amount in individual cases. (I hear anguished cries of 'how can we review 5,000 partly-completed tax returns individually?' The answer is partly that you do not necessarily need to do so as if the stage of completion of most of them is similar you can probably look at them as a whole; and partly that surely you have always done so in order to determine whether the realisable value of a contract was below cost.)
The ICAEW's new guidance also clarifies the following points:
(a) If there is uncertainty about the amount of revenue that will be earned, the amount to be recognised should be arrived at using a prudent estimate.
(b) If, like me, you do not recover all of your chargeable time, revenue should be based on recoverable rates rather than charge out rate. For example, if you sell your time at £100 an hour, but only recover 70% of chargeable time on average (i.e. on everything, not on that particular job) and your time records show time at selling price, it will normally be acceptable to bring into income 70% of the time on the clock — with the other 30% remaining as WIP.
(c) If the client always pays you nine months late and you pay 8% interest on your overdraft, it might be appropriate to recognise only 94% of the time on the clock and leave the other 6% in WIP (although in most cases the costs of doing the calculation are likely to lead you to decide not to make such an adjustment).
(d) If at your year end you are at an early stage of work, e.g. all you have done is write to clients for their tax return information, there may well be sufficient uncertainties that the prudent amount to recognise is nil. This was of course sanctioned by the court for the early years of a contract in Symons v Weeks [1983] STC 195.
(e) It is not necessary to apply spurious accuracy to the calculations; estimates will suffice.
(f) It is not appropriate to estimate and include revenue that relates to future activities. For example, a songwriter or singer should recognise broadcast royalties only when the song is played on the radio.
Work in progress
So, what will remain in WIP?
(i) The cost of speculative work where there is no contract in place and where there is a reasonable expectation that the cost will be recovered from someone.
(ii) Cases where a right to consideration does not arise until the occurrence of a critical event that is wholly outside your control (contracting with the client that he need pay you only when he signs the return would not meet the test — leaving aside that it sounds like commercial suicide — as the trigger, namely sending him the return, is within your control).
(iii) The costs relating to conditional or contingent contracts.
(iv) Cases where no reliable estimate of revenue can be made. These are likely to be rare.
(v) Cases where the point has not yet been reached at which there can be said to be any right to consideration because the work is at a very early stage.
(vi) The surplus of cost over income recognised, where there is a possibility of recovering it at a later date but it is not prudent to recognise the whole amount as income (although such surpluses should be written off if it is felt that the realisable value at the accounting date is nil).
I should make clear that the above reflects my view based on the ICAEW guidance; the guidance itself is silent on what will remain in WIP.
Conclusion
UITF 40 is part of UK generally accepted accounting practice (GAAP). Ignoring it will mean that the accounts will not comply with FA 1998, s 42(1) or ITTOIA 2005, s 25, as appropriate. Use of the financial reporting standard for smaller entities (FRSSE) does not provide a let out. This requires that, where an issue is not specifically covered by the FRSSE, accounting standards and UITF abstracts — although not mandatory documents — should be viewed 'as a means of establishing current practice'.
Accordingly, we all need to get used to life with UITF 40 whether we like it or not. It is here to stay. Anyone who still feels inclined to interpret it differently from the ICAEW should remember that HMRC will undoubtedly follow the ICAEW guidance. So if you decide to ignore it you at least ought to have the decency to warn affected clients to expect an HMRC enquiry into their next accounts!
Glossary and links
ASB — Accounting Standards Board
FRS 5 — Financial Reporting Standard 5, 'Reporting the substance of transactions' http://www.frc.org.uk/asb/technical/standards/pub0100.html
ANG — Application Note G to FRS 5, 'Revenue recognition' http://www.frc.org.uk/images/uploaded/documents/ACF562.pdf
UITF — Urgent Issues Task Force
UITF 40 — Abstract 40, 'Revenue recognition and service contracts', http://www.frc.org.uk/asb/uitf/pub0758.html
ICAEW:
-Frequently Asked Questions 5 March 2005 www.icaew.co.uk/viewer/index.cfm?AUB=TB2I_78336
-latest guidance www.icaew.co.uk/index.cfm?route
=135435.
SSAP 9 Statement of Standard Accounting Practice 9, 'Stocks and long-term contracts'
