The new accounting policy described at
BIM74270 will give rise to a one-off
taxable transitional adjustment in the first year in which it is
adopted.
The adjustment is calculated in accordance with FA02/S64 and
Schedule 22 for CT purposes and ITTOIA05/S226 onwards (Part 2
Chapter 17) for income tax purposes. An adjustment under these
rules can be positive or negative – taxable or relievable. If
taxable, the adjustment is called a ‘positive
adjustment’ for CT and ‘adjustment income’ for
income tax. This legislation is known as the ‘change of
basis’ legislation.
For further guidance on how to calculate the adjustment see
BIM34000 onwards and in particular
BIM34130. Although there must be an
accounting prior period adjustment to trigger the application of
the change of basis rules, the adjustment income or expense is not
necessarily the same as the accounting prior period adjustment
– it depends on how the various components of the adjustment
are treated for tax.
For income tax purposes the adjustment income arises on the
last day of the first period of account in which the new accounting
policy is adopted. It is earned income and although it is charged
separately from trading profits it is treated as profits of the
trade, profession or vocation for certain loss reliefs
(ITTOIA05/S232).
For CT, for periods of account beginning on or after 1
January 2005, the positive adjustment arises on the first day of
the period of account; for earlier periods the situation is the
same as for income tax (FA02/SCH22/PARA4). A positive adjustment is
chargeable for corporation tax as a receipt of the trade (see
BIM34070 – last section for more
on this subject).
If the old accounting policy does not comply with GAAP the
adjustment will not be within the change of basis legislation - see
BIM34020. The relevant figures will have
to be recalculated to comply with GAAP following the guidance on
invalid to valid changes – see
BIM34025.
In the case of a taxpayer adopting UITF 40, providing there are
no other tax adjustments (for example, disallowances for capital
expenditure) and no other changes in accounting policy, the
adjustment is normally the same as the accounting prior period
adjustment.
The accountancy is as follows:
The prior period adjustment resulting from the change to a
new accounting policy restates the opening balance sheet to what it
would have been had the new accounting policy been in place in the
previous period. In the case of UITF 40 the business needs to
calculate what the accrued income figure would have been at the end
of the previous period had the new policy been in place then. The
business also needs to revisit the work-in-progress figure, if any,
to remove any contracts for which the new policy would have
recognized accrued income and released work-in-progress to the
profit and loss account to match the revenue recognition.
For further information on calculating prior period
adjustments speak to an HMRC Compliance Accountant.
The following simple example sets out what might happen in
practice.
Serge is a self employed consultant. He draws up his accounts
to 31 December each year. He has no work in progress (see
BIM33170).
At 31 December 2004 he was half way through writing a report.
He estimated the report would take him 200 hours and it would be
finished in February 2005. His time records show that he had spent
100 hours on the report at 31 December 2004 and his contract shows
he will be paid £60,000 for the completed report.
In his accounts for 31 December 2005 he must include
both opening and closing figures for work to which
UITF 40 applies. He must restate the opening figures to increase
sales and debtors by £30,000 (half the value of the contract).
The prior period adjustment for accountancy purposes will be
£30,000. This figure is not credited to the profit and loss
account but is taken to the capital account (or profit and loss
reserve account).
As noted above the adjustment income for tax purposes on the
adoption of UITF 40 is normally the same as the prior period
adjustment - here the adjustment income is also £30,000.
