BIM74145 - Abolition of the cash basis: annex D to ICAEW note
This guidance relates to accounting periods before the
issue by the Accounting Standards Board (ASB) of Urgent Issues Task
Force (UITF) Abstract 40 in March 2005. UITF 40 applies for
accounting periods ending on or after 22 June 2005. Further
guidance is at BIM74200 onwards. See in particular Appendix 2
paragraph 1 in BIM74275 in relation to the ICAEW’s guidance
TAX30/98 (see BIM74130).
EXAMPLES OF THE VALUATION OF WORK-IN-PROGRESS
Example 1: Sole practitioner
John is a sole practitioner. He prepares accounts to 30 April
each year. John employs a secretary at a salary of £15,000 pa
but he has no other staff. His office rent is £6,000 pa and
other overheads average £8,000 pa. In his client’s
portfolio, has one large client Maximus Ltd on which he uses two
sub-contractors, Bill and Ben, each year. They do the bulk of the
work in March and April. In March 2001 Bill invoices John for
£2,000. Ben bills £3,000 but does not submit his invoice
until May 2001. John bills Maximus Ltd £10,000 in May 2001.
His agreement with Bill and Ben is that he will not pay them until
he is paid by Maximus Ltd.
There is no work-in-progress in relation to John’s own
time. There will however be work-in- progress in relation to the
time of Bill and Ben in respect of work done on Maximus Ltd. This
will be the direct cost of their work and will amount to
£5,000. It is irrelevant that Ben has not billed John by 30
April. As John has to prepare his accounts on an accruals basis he
will accrue for the amounts that he owes Ben but will then carry
that expense forward as work-in- progress. If Bill and Ben had not
completed their work by 30 April John would only accrue his
estimate of the part of their fees that relates to work done to
that date. Thus, in Bill’s case, John would accrue only for
the relevant part of the £2,000 and would then of course carry
the same amount forward as work-in-progress.
Example 2: Chargeable staff and materiality
Suppose that John in example 1 had trained his secretary to also
do bookkeeping work for two clients. She works 35 hours a week for
47 weeks a year (i.e. 1,645 hours a year). It takes her 5 hours a
week to do the book keeping work. It is billed monthly in arrears.
John charges each of the clients £200 a month for this
service.
Although there is no work-in-progress at 30 April 2001 in
respect of John’s time there will be some in relation to the
bookkeeping work. This might be calculated as:
| Secretary’s salary | £15,000 |
| NI 12.2% | £1,830 |
|
| £16,830 |
| Cost per hour: £16,830/1,645 | £10.23 |
| Work done but not billed for at 30 April 2001 |
|
| 4 weeks x 5 hours x £10.23 per hour | £205 |
| Work in progress | £205 |
John would probably not include the amount of £205 as
work-in-progress because it is not material. Even attaching
production overheads to the secretary’s cost per hour is
unlikely to render the figure material.
Example 3: Chargeable staff - accounting for work-in-progress
Peter and Paul are a two partner firm employing five chargeable staff plus two secretaries. Their profit and loss account shows the following
| Fees | £800,000 |
| Salaries, NI and pension contributions |
|
| professional staff | £140,000 |
| Secretaries | £25,000 |
| Rent and premises | £30,000 |
| Other overheads | £40,000 |
Peter and Paul record their work-in-progress at selling
price. At 30 April 2001, the work-in- progress was £240,000.
On analysis it is found that £105,000 of this is Peter and
Paul’s time and the rest staff time. An analysis of the fees
shows that Peter and Paul have billed £350,000 in relation to
their own time and £450,000 in respect of staff time.
There is no work-in-progress in relation to Peter and
Paul’s own time. There is work-in- progress in relation to
staff time. The total of £135,000 (£240,000 less Peter
and Paul’s time of £105,000) needs to be reduced to
cost.
The chargeable staff work a 35 hour week and occupy 40% of
the premises. Of the other overheads, Peter and Paul are of the
opinion that 50% of these costs are directly related to production.
Two possible methods of arriving at a figure of cost for
work-in-progress are as follows.
Method 1
One way to do this would be to use the ratio of the cost of work
produced by staff during the year to the market value of that work.
Thus, the calculation is as follows
| (A + B + C) -D | x Staff work-in-progress at selling cost |
| (E + F) - G |
|
where
A = the salaries, NI and pension costs of professional staff
- £140,000 in this case.
B = the rent and premises costs attributable to the
professional staff - 40% of £30,000 in this case, since they
occupy 40% of the premises, i.e. £12,000.
C = the proportion of the other overheads attributable to
professional staff - 50% of £40,000 in this case.
D = the cost of the opening work-in-progress - none in this
case.
E = the proportion of the total fees of £800,000 billed
in the year attributable to professional staff - £450,000 in
this case.
F = the selling price of closing work-in-progress
attributable to professional staff - £135,000 in this case.
G = the selling price of the opening work-in-progress
attributable to professional staff - none in this example.
The work-in-progress in this example is therefore
| (£140,000 + £12,000 + £20,000) | x £135,000, i.e. £39,692 |
| (£450,000 + £135,000) |
|
NB In this example, it is assumed for simplicity that there
is no opening figure for work-in- progress. If there was opening
work-in-progress, it would be necessary (as stated in the formula
above) to deduct its opening cost from the numerator and its
opening market value from the denominator.
Method 2
Another method would be to identify the hours of staff work-in-progress and multiply this figure by an estimated average staff cost per hour. In the example below, it is assumed that the staff cost per hour for each employee is based upon 1,820 hours, i.e. 35 hours x 52 weeks a year. The staff hours of work-in-progress of 2,100 come from the records.
| Total staff work-in-progress at selling price | £135,000 |
| Staff hours of work-in-progress | 2,100 |
| Average cost of professional staff is |
|
| Professional staff salaries |
|
| £140,000 | £15.38 |
| (5 x 1,820 hours) |
|
| Add: Production overheads |
|
| Rent and premises |
|
| (£30,000 x 40%) | £1.32 |
| (5 x 1,820 hours) |
|
| Other overheads |
|
| (£40,000 x 50%) | £2.20 |
| (5 staff x 1,820 hours) |
|
| Notional hourly cost | £18.90 |
| Value of work in progress is: |
|
| 2,100 x £18.90 | £39,690 |
There is no single right method to value work-in-progress. In
our view, either method should be an acceptable method of valuing
work-in-progress.
In practice, the Revenue accept that the materiality concept
would not require the inclusion of an overhead loading for such a
small firm. The overheads of around £7,400 are not material in
relation to the profit of the firm (which is over £550,000).
However, the example includes the overhead calculations by way of
illustration.
Example 4: Payments on account
Peter and Paul in Example 3 have set up a standing order for one
client, Joe Bloggs Ltd who pays them £1,000 a month on account
of fees. The main work on the job is done in June.
Peter is a little worried about the financial stability of
another client, Fred Smith Ltd, and accordingly asked the company
for £10,000 on account of the year’s fee in April 2001.
At that time the work-in-progress on the clock (at selling price)
was £8,000 of which £2,000 was Peter’s time and the
balance staff time.
How should these payments be reflected, if at all, in the
calculation of work-in-progress?
- Payment from Joe Bloggs Ltd
At 30 April 2001 Peter and Paul will have received £10,000 payment (i.e.: 10 payments of £1,000) from Joe Bloggs Ltd for work not yet done. That would not relate to work-in- progress. It would simply be carried forward in the balance sheet as a creditor as being amounts invoiced in advance.
- Payment from Fred Smith Limited
There are two possible ways to deal with the £10,000 from Fred Smith Ltd. Which is correct will depend on the exact transaction with that company. If Peter simply asked for a cheque the amount received is a creditor in the same way as that from Joe Bloggs Ltd. In addition Peter and Paul will have work-in-progress (calculated as in Example 3) in respect of Fred Smith Ltd of:
| (£140,000 + £12,000 + £20,000) x (£8,000 - £2,000*) = | £1,764 |
| (£450,000 + £135,000) |
|
* i.e. minus Peter’s time
If Peter invoiced the £10,000 as a payment on account
Peter and Paul would probably need to recognise at least part of it
(i.e. £8,000) as income and would then have no
work-in-progress in relation to Fred Smith Ltd, and a balance of
£2,000 will be handled in the accounts as a creditor on
account of work not yet done.
The Revenue may seek to challenge cases where there appears
to be an attempt to defer income recognition.
Example 5: Year end problems
When Peter and Paul prepare their accounts to 30 April 2001 they realise they have two problem areas.
- There is £15,000 time on the clock for M Owner Ltd. Last
year’s fee was £6,000. Another £2,000 of time will
be needed to finish the job. There is no way that M Owner Ltd will
accept a bill for £17,000.
- Peter did not realise that the cheque from Fred Smith Ltd has been dishonoured. A further £6,000 of staff time has been spent and the total time on the clock is now £14,000. Fred Smith’s financial problems are now so acute that it will clearly go into liquidation unless Peter spends further time on installing a new accounting system for the company.
M Owner Ltd
Peter and Paul will need to assess what they believe M Owner Ltd
will pay. Suppose they think it is £8,000. They then analyse
the £17,000 of time and discover that £6,000 is
Paul’s time and £11,000 staff time.
The cost of the staff work-in-progress is then
| (140,000+12,000+20,000) (per example 3) x £11,000 | = £3,234 |
| (450,000+135,000) |
|
As this is less than net realisable value of the contract the
work-in-progress is £3,234.
Fred Smith Ltd
As far as Fred Smith Ltd is concerned Peter and Paul would
probably decide that the likelihood of recovery of any of the staff
time is now remote and thus not recognise any work-in- progress in
respect of such time at 30 April.
If they think that Peter will need to incur, say, a further
£2,000 of time but will then be able to bill and recover both
that additional time and the whole of the £14,000 outstanding,
the work- in-progress at 30 April will be arrived at as in Example
4.
If they think that Peter will only be able to collect a
lesser sum they will need to from a view as to whether or not this
will be less than the cost figure in arriving at the
work-in-progress at 30 April.
