The View from No 50

 

 

 

 

September 2005

K P Bonney & Co

Chartered Accountants and

Chartered Tax Advisers

50 Cleasby Road  Menston

Ilkley  LS29 6JA

Tel:  01943 870933

Fax:  01943 870925

Email:  keith@kpbonney.co.uk

www.kpbonney.co.uk

 

 


WORK IN PROGRESS

 

Walter is a part time structural engineer.  He works for himself and he has only one client.  Each year he is required to prepare a report for his client on the condition of a bridge.  Walter is a creature of habit.  He always carries out his inspection on 30 June.  On the following day he writes up his report and sends it to his client, along with his invoice for £1,000.

 

As it happens, Walter draws up his own annual accounts to 30 June.

 

What is Walter’s profit for the year ended 30 June 2005?  Is it (a) £1,000 or (b) £1,500 or (c) some other amount?

 

Well if we were talking about the year ended 30 June 2004 the answer would be £1,000.  Those accounts would include the work invoiced in that year i.e. the work of 2003 invoiced on 1 July 2003.  No income would be recognised from the 2004 work on the basis that accounting practice did not require the likes of Walter to place a value on his own unbilled time at his year end.

 

But is it right that no value should be placed on the incomplete work at 30 June?  Would the accounts give a more meaningful representation of Walter’s circumstances if some value were placed on the incomplete work at June 2005?

 

This is a debate which has rumbled on in the accountancy profession in recent years.  The top accountancy brains have decided that the value of unbilled work like that described here should be recognised as income.

 

The decision is controversial.  A good many eminent accountants disagree with it.

 

The decision has a serious consequence for the likes of Walter.

 

The profit shown in Walter’s 2005 accounts will be £1,000 (being the work billed in 2004) plus the value of the incomplete work at 30 June 2005.

 

What is the value of the incomplete work at 30 June 2005?  You could argue it has no value at all.  What would the client be willing to pay at 30 June for the work in its then condition?  The answer is nothing because what he has ordered is a report and Walter has not even begun to write it.

 

So is Walter’s profit for 2005 £1,000 after all?  No, it isn’t.  The new rules provide that incomplete contracts like this should be valued to reflect the seller’s partial performance of his obligations.

 

In simple terms Walter must judge to what extent he has performed his obligations at 30 June and he must reflect as income in his accounts that proportion of the contract fee.  Thus, if he considers the work to be half complete, he recognises income of £500.  In this case his 2005 accounts will show a profit of £1,500.

 

So if your answer to the earlier question was (b) £1,500, you were right but only if you were working on the assumption that the 2005 work was half complete.

 

Answer (c) is the answer which is correct in all circumstances because the state of completion of all contracts must be considered individually.

 

Well that’s all very well for the accounting anoraks but it is of no real interest to business is it?

 

Wrong.

 

Individuals affected by this change of practice will feel its impact in their pockets on 31 January 2007.

 

The advancement of the recognition of income means that there is a ‘one off’ increase in taxable profit.  For most businesses this tax has to be paid on 31 January 2007 but there is no extra cash inflow from which to fund the payment.

 

The change will make a dent of thousands of pounds in the cash balances of many businesses.

 

Of course the Chancellor and the Revenue are just loving it.  This ‘problem’ is not of their making!

 

We accountants are just so embarrassed that our peers have introduced this costly change.

 

Who is likely to be affected?

 

In the main those whose business is to provide services over a period of time.  The main losers will be lowlifes like accountants and solicitors (no sympathy for these groups) but also affected will be worthies like architects, engineers and medical professionals.

 

What can you do to mitigate the impact of the change?

 

There are a number of things you can consider.

 

Perhaps the most sensible measure is to re-consider your terms of engagement and billing with your clients.  If you can bring forward your billings and collections you improve your cash flow, you should be in a better position to fund the January 2007 tax bill.

 

If you bill clients once a year then perhaps you should consider changing to quarterly or even monthly billing.

 

Even if you don’t increase the frequency of your regular billing you might consider billing your work in progress at your year end.  As you are going to have to measure and value your incomplete work at your year end you might as well bill it at the same time.

 

Is your business seasonal?  Are there times of the year when you have no work?  If so, you should consider changing your year end to one of these times.  You do not then have to trouble yourself with the measurement and valuation of work in progress.

 

Our Advice:  We shall write to all clients likely to be affected by these changes in the months before their year ends.  If you would like to discuss the impact of the change on your business cash flow and the measures you might take to mitigate the change please get in touch.

 

EVERY LITTLE HELPS

 

Revenue & Customs has published new advisory fuel rates which apply from 1 July 2005.

 

These rates are used by businesses to determine how much VAT they can reclaim on the mileage allowances they pay to car users.

 

The new rates and the corresponding VAT amounts can be viewed on the ‘Mileage allowances’ section of our website

 

www.kpbonney.co.uk/taxrates.htm

 

Our Advice:  If your business is VAT registered do not overlook the recovery of VAT on your mileage allowances.  For now, Customs allows you to reclaim VAT on these allowances and does not require you to have a VAT invoice.  If you have not been in the habit of reclaiming VAT on your mileage allowances you should consider making a claim for the last three years.  You could save yourself a tidy sum of money.

 

QUICK BUCK CHARLIE – CAUGHT TAXMAN, BOWLED EBAY….0.

 

Quick Buck Charlie manages to get his hands on two precious tickets for the final Ashes test match.  He doesn’t know one end of a cricket bat from another and he has no intention of going to the match.  Straight away he places his tickets for sale on eBay.  They are snatched up and he makes a profit of £1,000.  Result!

 

The tax rules on dealing like this are clear cut.  Anyone who buys and sells with a view to making a profit is carrying on a trade.  The profits of that trade are liable to tax.

 

For some time now Revenue investigators have been monitoring eBay to identify traders who may not be declaring their income from online transactions.  They are understood to be using the number of feedbacks a user has to determine which individuals are ripe for investigation.

 

Our Advice:  Use the tickets yourself and enjoy the cricket.

 

MONEY NO OBJECT

 

Mr Mourinho has been working for the billionaire Mr Abramovich for 25 years.  To celebrate the event, the billionaire says he would like to get Mr Mourinho a present.  So, Mr Mourinho asks for a set of golf clubs.  “How many are there in a set?” asks the billionaire.  “Fourteen”, replies Mr Mourinho.  “Should be able to do that”, says the billionaire.

 

A month passes and Mr Mourinho is starting to wonder if perhaps he should have been more modest and asked for a watch.

 

When Mr Abramovich calls again he says “I have got you some golf clubs”.  “Thank you”, says Mr Mourinho, “It is really kind of you and…….”

 

“Hey”, says the billionaire, cutting him off.  “It’s nothing.  I wasn’t even able to get you a full set.  Just the ten.  It’s worse than that too.  Only six of them have hotels within the grounds!”.

 

Copyright:  K P Bonney & Co LLP 2005.  All rights reserved.  No part of this publication may be produced, stored in a retrieval system, or transmitted in any form or by any means, electronic mechanical, photocopying, recording or otherwise without prior written permission of the publishers.  Disclaimer:  The publishers have taken all due care in the preparation of this publication.  No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the authors or the publisher.

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