Knowledge

The Valuation of Work-in-Progress

H M Revenue & Customs have issued Help Sheet IR233 - THE 'TRUE AND FAIR VIEW' FOR PROFESSIONS AND THE 'ADJUSTMENT' ON WITHDRAWAL OF CASH BASIS. This covers in detail the Valuation of Work in Progress The full document can be obtained from H M Revenue & Customs website.

It emphasises the importance of looking at the individual figures concerned where the book figure is valued at Selling Price. "Many professional business nowadays record Work-in-Progress at Selling Price. It would be conceptually wrong to value it at such a price when computing taxable profits. It is therefore necessary to reduce the book figure at Selling Price to arrive at the Cost of Work-in-Progress."

It points out that SSAP2 "...prohibits the carrying forward of current expenditure to the extent that it is not recoverable. If a Fixed Fee has been quoted for a job the value of Work-in-Progress will not exceed that fee less the estimated costs that will need to be incurred to complete the job." Both the above quotes are taken from page 4 of the Inland Revenue Help Sheet IR233.

How much do your clients want to pay you?

Nothing, or as little as possible, I hear you say; but that surely doesn't ring true. If you set up shop selling your time and expertise for no charge, you would not be trusted by your prospective clientelle, why...? - Well, to put it quite simply, only an idiot would give his/her time away for nothing and who wants advice or technical expertise from an idiot?

There are quite a number of prospective clients who are 'bargain hunters', their main aim in life being to get through each day spending as little as possible on everyday things so that they can buy extraordinary things which may be a little more expensive. The trick is to change their perception of you and your services so that they believe that you, and the services that you provide, are extraordinary! Your client must believe that he/she can't get the service that you give him/her from anyone else at the price!

The long and the short of it is, if you want to be valued more than your competitors and be paid more than your competitors, then you've got to offer a better 'product'!

The 'product' or service that you offer a client is not the sum total of the tangible bits that he/she ends up with; it is the sum total of all the contact he/she has with you, and your employees, your bits of literature, your family, other people who have opinions about you, your employees, your family, your literature...

Some of your competitors may market themselves as offering expensive services to those 'discerning clients' who know where the 'best service' can be obtained; but is it really the best service? Is it just expensive? At the other end of the scale, some of your competitors may operate out of the back of a car, have little or no overheads, and offer a 'cheap service'. The clients of either competitor won't choose them simply on price; there will be other factors. Those who operate on low budgets, offering cheaper services than you can supply, often have to 'bend over backwards' and do the things that you and your competitors can't do. (Are you available for your clients outside 'normal' office hours?) Those who have large budgets may be able to provide, from within the firm, a technical expert on virtually any area that may be potentially of use to their client. (Do you have phenomenal expertise on every area which may be potentially of use to your clients?)

If you are going to 'gear' and price your services according to what your prospective client base values, then your first step must be to find out what that is. Find out what your competitors are supplying and examine where they meet (and fail to meet) your clients' requirements. Don't ignore one extreme or the other, see what you can do within your firm to adopt those elements that meet your clients' requirements.

This may be simpler than you think. You and your employees may be used to working from nine to five each day and consequently only supplying your services to your clients during these hours. Some clients may want you and your staff to be available at other times of day. Some members of staff may prefer to work more flexible hours for personal reasons. For example you may find that some members of staff may want to set off from home later to avoid travelling during 'rush hour'. Some may prefer a couple of days off during the week to two days at the end of the week.

Getting the right 'service package' for your clients at a mutually acceptable price, is the result of a continual process of evaluating the services you offer and monitoring both client satisfaction and changes within your marketplace. Recording and monitoring the work that you do is a small, but important part of that evaluation process. It can help you to deliver a highly-valued service to your clients.

Pricing

Pricing is a difficult area for professionals to master. Value Pricing is an excellent theory, but to negotiate a price, based upon the perceived value to the client, is fraught with difficulty. Fixed Fee arrangements have been in effect for a considerable period of time and have always featured heavily in the pricing of accountants' services; although many Fixed Fees have been tacitly agreed rather than explicitly so. It makes sense to use computer software to try reduce the element of risk attached to Fixed Fee agreements.

Measurement of the process, 'what we do', and of the overall performance, is essential if an organisation is to have effective control over the process to positively affect performance; without it, the organisation cannot correctly amend the criteria used as the basis for future Fixed Fee agreements. Continually monitoring the performance of the organisation, and measuring that performance against that of its' competitors, is essential if the organisation is to remain in the competitive arena.

Costing your time

Work out how much your time at work costs per hour and per minute.

1.5 x annual salary = Cost per hour

        Working hours per year

Cost per hour     =     Cost per minute

                         60

The multiple of 1.5 is an attempt to include overheads. Many accountants use *1.25 - it really does depend on your individual circumstances.

If you have higher overheads use a factor of 1.5 or more; if you have lower overheads use a factor of 1.25 or less.

* 1.25 is suggested as being a common multiple in "Setting Up in Practice by James Carty F.C.C.A. F.C.A. - Published by A.C.C.A July 1999"

Discussion Point: Valuation of Work in Progress for longer term contracts

Longer term contracts are often a major part of turnover and valuing a contract at any stage of completion at it's cost to date presents it's own inaccuracies. If one takes the costs to date at any stage of the project as the work in progress value, there could still be a rather large change in turnover when the project is completed (if no account is taken of income until then). Should a proportion of overheads be included within such a work in progress valuation? The situation becomes even more complicated if, as with the vast majority of contracts, payments are received from the customer over the life of the project. What value of work in progress, if any, should be used in such circumstances? Certainly, as soon as any income is received for a contract, valuing work in progress at 'costs to date' also becomes inaccurate. So how should work in progress be valued in such circumstances?

A 'true and fair view' of Work in Progress may require some longer term contracts (which may be less than one year in duration) to have income (and as a consequence, profits) spread over the life of the contract.

This could be calculated on a 'percentage completed' method. Say, for example, that the overall project is valued at £100,000 The first valuation (25% complete) was £25,000 value of Work in Progress £25,000; you received income of £23,750 (they kept a 5% retention) value of Work in Progress £1,250. Your second valuation (50% complete) was £25,000 value of Work in Progress £26,250 (£50,000 less £23,750); you again received income of £23,750 value of Work in Progress £2,500. Your third valuation (75% complete) was £25,000 value of Work in Progress £27,500; you again received income of £23,750 value of Work in Progress £3,750. When the project is complete, your final valuation is £25,000 (total £100,000) value of Work in Progress £28,750. This time you receive £26,250 leaving a total retention of £2,500 for the project.

An alternative treatment of the above over the life of the project is to treat each valuation as being income and included within turnover figures, with the amount of the retention at any stage (be it 2.5% or 5% or whatever) being shown as an asset in the Balance Sheet. H M Customs and Excise certainly favour the latter as they would then gain the benefit of the VAT on the full valuation each time, except in cases where the VAT was calculated on a cash received/cash paid basis (Cash Accounting). This method takes no account of work in progress at all! So are we back to square one?