Income recognition: changes in the service sector

Consider the following…..

Your business has negotiated a consultancy contract with a customer for an agreed fee of £20,000. The contract is halfway to completion at your 30 September 2005 year end. The total costs of providing the service are expected to be £12,000 (and this is mostly salaries) leaving £8,000 of profit.

In the past, the full £8,000 of profit would have been reflected in the accounts for the year to September 2006. The £6,000 (ie half) of costs incurred by September 2005 would have been carried forward as work in progress.

For accounting periods ending after 22 June 2005, income from incomplete contracts must be included in the accounts to the extent to which the contract has been completed (under the terms of UITF Abstract 40). Smaller businesses adopting the Financial Reporting Standard for Smaller Entities (FRSSE) must do the same for accounting periods beginning on or after 1 January 2005.

Now….. instead of £8,000 profit being reflected in the 2006 accounts, effectively £4,000 will be included in the 2005 accounts and the other £4,000 in the 2006 accounts.

And…you guessed it, the tax treatment will follow suit and there is no provision to allow any spreading although the professional bodies continue to push for this.

Some thoughts if you are likely to be affected:

given the choice, focus on completing existing contracts as your year end approaches and defer new work until after the start of your next financial year
ensure you have efficient invoicing and cash collection procedures so that at least you have the funds to pay the tax.