On 13 November 2003 the Accounting Standards Board issued a new Application Note to Financial Reporting Standard FRS 5 “Revenue Recognition”. David Collison, Chairman, CIOT Personal Taxes Sub-Committee, has written as follows. This will appear in the Noticeboard section of the February issue of Tax Adviser. This new Application Note states as a Basic Principle: “Where a seller has partially performed its contractual obligations, it recognises revenue to the extent that it has obtained the right to consideration through its performance ….This will normally be the price specified in the contractual arrangement.” (paras G6 & G7) The Note states as “Required accounting”: “…the seller … should report turnover based on the gross amount receivable in return for its performance under the contractual arrangement.” (para G67) The Application Note applies to accounts for periods ended on or after 23 December 2003.
The “true and fair view” that is required to measure profits for tax purposes (vide FA 1998, s42) requires the application of accounting standards, whether the entity is a company, a partnership or a sole practitioner. Hence, the issuing of this Application Note to FRS 5 has a direct tax effect to professional firms of whatever type.
Applying the Application Note when drawing up the accounts of a professional firm requires us to ascertain the contractual arrangements between the firm and its clients. If the contract is that the client is obliged to accept bills for hours worked, the effect of the Application Note is that the profits of the professional firm will be measured by reference to the hours worked in the accounting period, measured at selling price, whether or not an invoice has been raised by the year end.
FRS 5 para 13A states that this Financial Reporting Standard does not apply to entities that adopt the Financial Reporting Standard for Smaller Entities (FRSSE). The limit for this treatment has now been raised to turnover of £5,600,000. However, no firm that is registered under Financial Services Act 1986 is allowed to use the FRSSE. More fundamentally, the view is taken that the effect of FRSSE para 2.1 is that the treatment in the new Application Note must be applied to smaller entities, as para 2.1 states that a smaller entity is required “to identify whether the transaction has given rise to new assets”.
A question that the new FRS 5 Application Note does not specifically address is whether the time of the sole practitioner or partners must be removed from the accounts of any unincorporated entity when this new treatment is applied. This principle is fully endorsed by the Revenue for the valuation of professional WIP (see IR Business Income Manual paras BIM74075 and 74080 and the Revenue endorsement of these examples in BIM74085). However, if the effect of the new Application Note is that the WIP on an hourly-charged job is treated as a billable debtor in the year end accounts, there must be doubt as to whether the exclusion of the proprietor’s time is appropriate. Some practitioners have expressed the view that there would be no such exclusion, even if the calculation is merely to increase the value of WIP.
Chairman, CIOT Personal Taxes Sub-Committee
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