TT64: New Accounting Standards

No more room for manoeuvre

New accounting standards have been issued in the UK that attempt to harmonise UK accounting standards with International Standards. The standards have been introduced because businesses have used the lack of specific standards to measure income recognition (i.e. accounting for sales) to either delay or advance the reporting of profit – depending upon their needs. How was this done?

Delaying profits

To achieve this, accounting for the sale would only be recognised at the end of a job. Until that point work in progress would be accounted for at cost. This delayed the profits on the service until the latest possible date.
Accelerating profits
As an opposite alternative, sales were recognised immediately and a minimal amount of the sale was deferred to match the costs of finishing the job. This advanced profits to the earliest possible point.

Effects of the new standards

Broadly speaking these will be felt in two ways:

  • A seller must recognise income when it obtains a right to consideration from its performance of the service – this is not the same as when all the contractual obligations have been fulfilled
  • Income recognised in advance of invoicing date will be shown under debtors as ‘amounts recoverable on contracts’

For example, if you are half way through an assignment at your year-end you must provide for half your fee, thus “work in progress” will only be shown in accounts in exceptional cases where the contracts concerned are truly conditional or contingent upon future outcome.

Who will be affected and when?

All companies providing services will be affected; the date of implementation of the new policy will depend upon their size. Small companies* will adopt the new changes for accounting periods starting on or after 1 January 2005. Other companies that do not qualify as small will have to adopt the changes for accounting periods ending on or after 22 June 2005, potentially a lot earlier. Unincorporated entities (e.g. professional service firms such as Solicitors) are required to prepare accounts for the Inland Revenue that comply with accounting standards.Which standards they must use is dependant upon their size as if they were companies.

* To qualify as small a company must pass two of the three following limits for two years in a row: £5.6M turnover, £2.8M gross assets and 50 employees. Additionally it cannot be a Plc or licensed under the Financial Services & Markets Act 2000 (e.g. Independent Financial Advisors), or be a member of a group containing such a member.

Barnes Roffe Topical Tips

  • Plan in advance for the change that this will make to your accounts
  • Previous accounting periods must be restated to show the new policy as if it had always applied, so start to gather information now to make the transition easier
  • Income and profits might be advanced to an earlier period, so plan ahead to mitigate the tax bill
  • Consider changing the billing policy of the business to reflect the accounting policy, hence advancing cash flow to match
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