Accounting for long term contracts
Construction type companies are subject to a special accounting standard called IAS 11 (see http://www.ifrs.org). This standard specifies how construction companies deal with revenues and costs associated with contracts in their published accounts. What’s the problem you might ask? Why a special standard? The problem is that construction or similar contracts often span multiple accounting periods. If too much revenue is recorded early, profits might be inflated incorrectly. And, if costs are recorded too early, profits might look much lower than they should be. So, IAS 11 says what is allowed and not allowed. In a nutshell, losses must be included in accounts immediately; profits should be reported only when certain and in proportion to the completion of a contract. A recent news article in the Telegraph highlights one UK company (Connaught Group) that may be incorrectly applying the standard – you can read it here – to long term social housing maintenance contracts.
In fact, IAS 11 applies two basic accounting concepts. First is applies the prudence concept, as losses are to be recognised straight away and profits only when reliable estimates are possible. It also applies the accruals concept, which means that revenues and costs should be matched against each other as evenly as possible over time.
The use of the word ‘fair’; some thoughts for accountants
In accounting we use the word ‘fair’ a bit. ‘Fair value’ and ‘true and fair view’ are two key concepts that come to mind. But what is fair, and what is unfair. What might be fair to you, is unfair to me and so on. And then, what if we try to translate ‘fair’ into other languages. Does it retain it’s meaning. I don’t know to be honest as I’m not a linguist. But as an accountant, I’m sort of programmed to think logically and look for a definite answer. But maybe there isn’t one. To get you thinking, have a read of this piece from economist.com. It’s a bit a bit of fun on the use of the word ‘fair’ around the recent emergency budget in the UK.
IFRS for SMEs
I have written previously about the FRSSE, which is a summarised set of accounting rules used by some private companies in the UK and Ireland. Since 2005, all public companies throughout Europe use what are called International Financial Reporting Standards (IFRS). These standards are complex and the bound volume runs to a few thousand pages. Not the sort of thing a smaller private company might find all that useful when preparing its financial statements. In the UK, a body called the Accounting Standards Board (ASB) is responsible for implementing all accounting standards. In August 2009, the ASB decided to adopt the IFRS for Small and Medium-sized Entreprises (IFRSSME) with effect from January 1, 2012. According to accounting firm Deloitte (see this link), this means that approximately 50,000 larger private companies will have to adopt the IFRSSME, while about 2 million others can continue to use the FRSSE. Unlike its big cousins, the IFRSSME is small and compact, at around 230 pages of rules. The International Accounting Standards Board (IASB) hope that the IFRSSME will meet the needs of SMEs, who typically account for 90-95% of businesses in any country. Unlike the full IFRS, the IFRSSME is not compulsory in the UK or any other EU nation, but watch this space.
The IFRSSME can be downloaded free at this link.