UITF Abstract 40

Changes in the requirements applying to the calculation of income for accounting purposes which came in during 2005 had a significant effect on all businesses which supply services under a contract to their clients and customers. The most common types of affected business are professionals such as solicitors and accountants, but the change in the rules can affect almost any service based business, from builders to farmers who are paid to grow certain crops (rather than selling the crops they have grown).

The new rules require that unfinished work at the end of the accounting period is taken into account at selling price, so that an element of profit on unfinished work is recognised in the period in which the services were performed. This is a change because previously, the business would merely carry forward any costs relating to the work and recognise the profit only in the period in which the work is completed.

Businesses adopting these rules, known as UITF Abstract 40 had to put through an adjustment in the accounts which included the start date of 22 June 2005, which was in effect a 'catch up' of all extra profits outstanding at that date. This, of course, gave rise to a large tax liability on the extra income.

The professional bodies raised their concerns about the extra tax coming all in one payment and rules were introduced to allow this income to be spread over between three and six years. This means that you may still be paying the tax on the additional income which arose as a result of the change. This extra income is known as the catch up charge, and is liable to tax but not Class 4 National Insurance contributions.

The effect of the spreading rules can be very complicated if there is a change in the partners in a firm or the partnership profit shares, so you should ask for advice about the likely impact of these changes.

We shall need to discuss with you the basis of valuation of uncompleted contracts at your year end, and you may need to develop a special system of recording unfinished work to allow your accounts to accurately report the profit for the period.