Work in progress (WIP) is a difficult concept to understand probably because it was devised by accountants!  It is an attempt to try to match business income income with business expenses.

What surprises me is how many accountants ignore it when preparing their client’s accounts, probably because they think it doesn’t apply to sole traders and partnerships – but it does.

In simple terms WIP is the value of work done started prior to the year end but not invoiced until the following year. The valuation must include all the costs incurred on the “project” up to the year end and and it must include the amount of profit to the year end although it should also take into account the actual amount received on completion.

The attitude of HM Revenue & Customs is simple. They state in their manuals:

“it is inappropriate to defer recognition of revenue until contract completion”

The accountancy bodies have issued a guide to assist small businesses, particularly those that might not have kept detailed records. It applies to all service providers.

The following extracts from the guide should help you understand the concept of WIP:

1. Where a service contract straddles a year end, it should in principle be accounted for as a long-term contract. This means that revenue should be recognised “as contract activity progresses to reflect the seller’s partial performance of its contractual obligations”. So in a simple case, where a contract is for £10,000 and it is half performed at a year end, the seller should recognise revenue of £5000

2.  Generally, if there is uncertainty about the amount of revenue that will be earned, the seller should make a prudent estimate of the recognisable revenue. If in a rare case no reliable estimate can be made, revenue should not be recognised.

3. If a professional firm works on the basis of charge out rates that are not always fully recovered, revenue should be recorded based on likely (lower) recoveries rather than actual charge out rates.

4. Each contract that is in progress at the year end should be considered.