Work In Progress and Deferred Income – what it all means

(Last Updated On: 29th March 2018)

When it comes to your year end accounts, we ask our clients to help identify their Work In Progress and Deferred Income. We know it can be a bit confusing, but it’s very important and can have a significant impact on your profits and corporation tax or income tax and even the amount of dividends you can declare from your company.

So we have set out some guidance and examples below to help make these accounting concepts seem less daunting! Hopefully….

Firstly, what is Work In Progress (WIP). This is also often referred to as Accrued Income. They are essentially the same thing.

Now as most of our clients aren’t manufacturers, we are not talking here about a good which is partly assembled. For example if you have an assembly line making chairs. And you have some chairs at year end which have a seat and arms but no legs yet. Then those are Work In Progress rather than Finished Goods or Materials.

Instead what we are talking about here is more concerned with the service industry.

So our accounting definition is:

Income that has been ‘earned’ but not yet invoiced by year end.

By ‘earned’ we mean you have done the work.

Googling the definition of Accrued Income generates a few different results, which would actually give a very different amount of profit!

So here are some examples following the way we account for Accrued Income or WIP (all with 31 March 2018 year ends):

 

  1. Lisa runs a small creative design agency. She invoices her clients at the end of each project, and sometimes in stages throughout the project if it’s a long one.

She has a project which she started on 1 March 2018 and will run to end of April 2018.  The total fee is £10,000 plus VAT and she will invoice the client on 30th April. She checks her teams progress on the project at end of March and can see they’ve done 60% of the work by then.

Therefore her WIP is:

£10,000 * 60% = £6,000.

So although she invoices on 30th April 2018 and gets paid in May 2018. For her 31 March 2018 year end accounts, we would record £6,000 of sales and that the £6,000 is WIP owed to Lisa’s company.

 

  1. Barrie runs a marketing consultancy and without fail invoices all of his clients on the 1st of the month for the previous months work.

At year end his WIP would be the value of his sales invoices dated 1st April 2018.

He also sometimes incurs costs on behalf of his clients, e.g. Facebook Pay Per Click. He invoices his clients on the 5th of the month for these disbursements for the previous calendar month.

Therefore at his year end all the invoices on 5th of the month are also WIP.

 

You’ll notice in both these examples of WIP (and Deferred Income too), it is the invoice date and not the date of payment that matters. We also ignore VAT in 99% of instances.

 

Let’s now tackle Deferred Income, also know as Income In Advance. This is the opposite of WIP.

Our definition of Deferred Income is, income that you’ve sent out a Sales Invoice for but where you have not performed the service in full, or delivered the goods yet.

Some examples for you (all with 31 March 2018 year ends):

 

  1. Kelly is a small business growth consultant. She offers her clients a discount if they pay upfront for a package of meetings. In March a client takes her up on the offer and she invoices them on 10 March 2018 for 10 meetings at £500 each meeting, so a total of £5,000 plus VAT. Kelly performs two of those meetings before 31 March 2018.

Therefore at 31 March 2018 her Deferred Income is:

8/10 * £5,000 = £4,000  (i.e. 8 of the 10 meetings are done after 31 March 2018, so £4,000 of that sales invoices relates to work done post year end.

 

  1. Robin is a chiropractor. He either invoices and gets paid at the time of the treatment, or he sells 12 sessions as a package up front.

At any point in time he will have many clients on these 12 session packages. Luckily for him he can run a report from his Clinic software which shows all clients on packages and how many treatments they have left to take at 31 March 2018.

All he has to do is run the report!

 

Unlike Robin, Kirsty has a similar business but uses spreadsheets to manage her business. At the end of March she has to look at each client who has bought a 12 session package which wasn’t all used up by 31 March 2018 and record the number of sessions yet to take and the value of those sessions;

E.g. Her patient Mary bought 12 sessions on 3 Feb 2018 for £360. By 31 March Mary had used 6 sessions. Therefore the Deferred Income was 6/12 * £360 = £180.

And Kirsty is going to have to collate that data for each patient with a package.

 

  1. Trev runs a website development company. As part of their work they sell hosting to their clients. The hosting is invoiced once a year.

For each hosting invoice, he will need to collate data to show the value of the annual hosting and the time frame it relates to, e.g.

Invoice 324 for £500 plus VAT for period 7.6.17 to 6.6.18.

The deferred income can then be calculated either on a day basis or rounded to the nearest month:

2/12 * £500 = £83.33 Deferred Income.

 

And lets not forget Grant Funding or contracts with public bodies. We often see clients who are asked to invoice for all the funding for their project before 31 March 2018 so that the Grant Funder or Public Body can show the spend in their 31 March accounts.

But when it comes to our client’s accounts, they will still need to assess if any of that invoice relates to work they did post their year end and apply the same methodology as the examples above.

 

In Conclusion

As you can see depending on how much WIP and Deferred Income you have it can take quite a while to work out which invoices this applies to.

In our experience it’s best to do this work near to your year end as it can be hard to go back and dig through data and remember what happened. Even better if you have existing software from which reports can be run to give you the info at the touch of a button.

We’re on hand of course to do the calculations, but we need your insight to collate the data in the first place.

 

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