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WORK
IN PROGRESS - A CONTRARY VIEW
An article by Robert Maas - 26.01.04
Not
for the first time I find myself out of step with some
of my fellow professionals, including, it appears, Andrew
Disley (Taxation 22.1.2004). I think that he is worrying
unnecessarily. I do not believe that the amendment to
FRS 5 has any significance for the vast majority of professional
practices. I do not propose to change one iota the way
that Blackstone Franks LLP deals with work-in-progress.
My partners, very sensibly, do not let me near clients'
accounts but if they seek my view I will tell them to
carry on as before.
Before
panicking I suggest that readers take a look at what the
amendment to FRS 5 does. It first sets out a basic principle,
namely that, "A seller recognises revenue under an
exchange transaction with a customer when, and to the
extent that, it obtains the right to consideration in
exchange for its performance". (para G4) What is
controversial about that? It is what I have believed to
be the appropriate accounting treatment ever since I became
a chartered accountant, getting on for 40 years ago. Secondly,
it gives specific guidance in five specific areas, two
of which, long term contractual performance and separation
and linking of contractual arrangements, might apply to
work in progress and the others of which will not. I can
also see no logic in assuming that the statement that
"the Application Note does not apply to the following
arrangements… those which are dealt with more specifically
elsewhere in …other accounting standards" (para
G1) is somehow intended to override SSAP 9.
But back to G4. When do I get a right to consideration
in exchange for my performance of professional work for
a client? The standard tells me it is when I have fulfilled
my contractual obligations to a customer through the supply
of services (para G3). Suppose for example I contract
to complete a tax return for a client. I start it on 25
April and discover that I do not have all of the information
I need. I write off for the extra information which I
get in June. What contractual obligations have I performed
at my accounting date, which is 30 April? Answer: None.
I have contracted to complete a tax return and I have
not fulfilled that contractual obligation. Accordingly
the standard does not allow me to recognise any income
- but SSAP 9 will of course require me to carry forward
the costs, if any, incurred up to 30 April as work-in-progress,
as such costs relate to income that I expect to generate
in the following year. An example should make this clear.
Suppose on 1 May I decide that I am fed up with tax and
never go back to work again. Can Blackstone Franks say
to the client "Robert has left the firm without finishing
your tax return so you will have to get someone else to
do it, but he has done a bit of it so you have to pay
us for that bit"? Well, they can say it, but what
the client will say in return is unprintable. If I have
contracted to complete a tax return it is irrelevant that
I did some of the work before walking away from the contract.
I would not have fulfilled my side of the bargain and
in those circumstances cannot expect any amount of debt
or cash in exchange for doing the bit of the work that
I deigned to do.
Of course at the stage I fulfil my contractual obligations
to the client in full I become entitled to be paid. Para
G4 requires me to recognise at that stage that I have
exchanged my services for a debt and need to include the
value of that debt in turnover. But, again, what is new?
That has always been the position. When the Tax Faculty
agreed TAX 30/98 (Withdrawal of Cash Basis: Guidance note
on a True and fair view) with the Revenue in 1998, we
said at para 48: "Profit cannot be deferred by leaving
jobs in work-in-progress after they have reached a billable
stage. Once a job has been completed the billable amount
should normally be recognised as a debtor rather than
work-in-progress."
Of course this may beg a question of when is a job completed.
That is often not clear cut. The building industry has
a concept of "snagging"; the job's not done
until the customer has had a chance to look at it and
demanded that botched work is put right and omissions
are rectified. Personally I think that concept applies
to much of what accountants do too. If I am asked to advise
on a situation I do not think I have completed the assignment
immediately that I write to the client with the advice.
He may not understand it. I may have overlooked something
or misunderstood something I had been told. In my view
I have not performed my contract until the client has
had a reasonable chance to read the advice and come back
with further questions or comments. If I were to send
a bill in with the advice letter I doubt I could charge
for the time I spend later explaining or amending the
advice.
However, I do not believe that I can choose when to bill
and recognise the income only when I do so. If the client
has not responded within a few weeks I think that I must
then recognise the work as complete and regard the fee
that I intend to charge as a debtor for accounting purposes.
I can see nothing in the revision to FRS 5 to change my
view in any way.
On long term contracts the Amendment says that the Application
Note provides additional guidance but does not amend the
requirements of SSAP 9. (Para G 14) In other words nothing
has changed unless you have been applying SSAP 9 incorrectly.
What the additional guidance seems to me to say is no
more than if a right to consideration crystallises during
the course of the contract the seller should recognise
income at the time that that right accrues, but the amount
that falls to be recognised at that time is not necessarily
the amount of the consideration that becomes due at that
stage; the probable overall result of the contract needs
to be considered in deciding how much to recognise. Suppose
for example I contract to carry out an assignment on terms
that I will be paid £5,000 when I have performed
a specified part of the work and a further £10,000
when the whole work is completed. The amended standard
says that when the £5,000 becomes due I should recognise
something as income. That something is not necessarily
£5,000. If I think that I am going to make a loss
on the entire job, or a smaller profit than I anticipated,
I should probably recognise such an amount as reflects
a third of the overall anticipated profit if that is less
than £5,000. I do not think that is much different
to how I have always interpreted SSAP 9.
However, the point that needs to be made is that most
of us do not contract with clients for stage payments
to become payable when individual sections of an assignment
have taken place (as opposed to payments in advance, such
as by regular standing orders, which are treated different).
We contract to perform the entire assignment and earn
the whole of our fee when we have performed it. Accordingly
the long term contract parts of the Amendment seem to
me to be aimed at people like architects or builders who
do obtain a contractual right to payment for work done
at specific points during the contract. It will rarely
apply to accountants or solicitors.
The new guidance on separation and linking of contractual
arrangements also seems to me either to have no application
to accountants and solicitors or possibly to defer the
time that income is recognised. What it says is that a
commercial arrangement which embraces several distinct
services, eg the writing up of a client's books and the
preparation of accounts, can be split down into separate
services only if the commercial substance is that the
individual components operate independently of one another.
In my example I do not think the two activities can be
"unbundled". The reality is that the client
does not want the books; he wants the accounts. I cannot
bill him for the book-keeping and walk away without doing
the accounts and expect to be paid. The two tasks are
commercially inseparable as the accounts cannot be prepared
without the books being written up and writing up the
books alone has little or no value to the client. Accordingly,
even if my contractual arrangements were to provide for
a stage payment when the books are written up, I cannot
simply treat that stage payment as income at that time;
I need to form a view as to the likely results of the
overall assignment in deciding what to recognise them.
I would also point out that although the concept of prudence
disappeared with FRS 18, as FRS 18 itself makes clear
(at para 12 of Appendix IV), it is still a "desirable
quality of financial information". To throw caution
to the wind and recognise income before it is earned would
be such a departure from normal accounting practice that
I think it inconceivable that the ASB would do so without
at least explaining why, particularly as the Application
Note itself states that its intention is merely to codify
existing good practice. (para 10 of "Development")
Finally the trigger for the Amendment, as set out both
in the Preface to the Exposure Draft issued last February
and in the note at the end of the Amendment itself, is
expressed to be that, "In recent years it has become
common for investors in certain industries and start up
businesses to focus on revenue growth as an important
indicator of a company's ability to meet its targets and
achieve (or regain) profitability. This has led to, or
highlighted, certain divergences in accounting treatments".
I infer both from this and from the specific wording of
the application notes that the worry of the ASB is not
that businesses are understating their income but that
they are anticipating income prematurely in order to demonstrate
revenue growth.
For something with such an objective to actually require
people to recognise profits earlier than they otherwise
would have done indicates either staggering incompetence
or a high level of deviousness. I do not believe either
of the ASB. This reinforces my view that the standard
is neither intended to bring about the earlier recognition
of profits and nor does it do so.
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