UITF 40 - Revenue Recognition and Service Contracts

a) UITF 40 is part of UK generally accepted accounting practice (GAAP) and applies to professional and other services under contracts which span an entity?s year end.
b) Does not apply to goods, only services.
c) Financial Reporting Standard for Smaller Entities (FRSSE) 2007 specifically includes requirement for small entities to comply
d) Unbilled income at balance sheet date should no longer be valued as work-in-progress (WIP) at cost, but as turnover at fair value i.e. accrued income (AI)
e) In effect income recognition has been advanced by uplifting the valuation of WIP from 'cost' to 'fees' (selling) value, resulting in additional tax liabilities
i) WIP
(1) Based on the concept of matching income with the expenses incurred in generating the income
(2) For short term contracts, incomplete work has to date usually been valued at lower of cost and net realisable value, in accordance with Statement of Standard Accounting Practice (SSAP) 9
(3) Includes staff salary costs and overheads
(4) Does not include cost of owner?s time
ii) AI
(1) Revenue or income builds up over the life of the contract, rather than when the work is completed or the client is invoiced
(2) Income is recognised once the entity is contractually entitled to raise a fee.
(3) This is a critical point in time at which WIP becomes AI
(4) Profits for distribution must include AI
(5) Fair value of AI is likely to be a proportion, pro-rata, of the ultimate selling price to reflect the amount of work completed at balance sheet date
(6) Includes cost of owner's time
(7) Shown in balance sheet as 'Prepayments and Accrued Income' or 'Other Debtors'
f) UITF 40 applies to all accounting periods ending on or after 22 June 2005
i) Rules are retrospective as previous year's accounts are revisited to remove WIP and introduce a figure for AI instead
ii) A prior period adjustment is made to the accounts for the first year using the new method
iii) The adjustment occurs in one year only, the year in which the new accounting policy is adopted
iv) Likely to be a one-off increase in tax i.e. if the adjustment increases profit
v) The adjustment is not taxed in one year but spread over 3 to 6 years, depending on size of adjustment
vi) Taxed separately as 'Adjustment Income'
g) Where the future amount of revenue earned is uncertain, a prudent estimate should be made
h) Estimates will suffice
i) If the contract is at an early stage, there may be sufficient uncertainty that the prudent amount to recognise is nil
j) The following will remain in WIP
i) The cost of speculative work where there is no contract in place and where there is reasonable expectation that the cost will be recovered
ii) Where a right to consideration does not arise until the occurrence of a critical event wholly outside the entity's control
iii) Where the point has not yet been reached at which there can be said to be any right to consideration because the work is at a very early stage