Accounting for pre-contract costs Amey is a UK-based support services group. It provides a range of services – from IT support to property maintenance – for public sector and private sector organisations that have decided to outsource these activities. According to the chief executive, 2001 was a good year. Group revenues increased 19% to £786 million. The company had an 80% bid success rate, winning contracts with a total value of £1,890 million that year. However, 2002 saw it competing for major London Underground modernisation contracts and there were doubts whether it could maintain this bid success rate.

The company changed the way it accounted for pre-contract costs in its 2001 accounts. Until then, it had capitalised as an asset (under ‘deferred charges’) the costs incurred in bidding for new contracts where it was reasonably certain it would recover the costs. (Evidence of ‘reasonable certainty’

was a cost indemnity or the company’s appointment as preferred bidder.) Capitalised costs were amortised against income arising on the related contracts. The new policy is to expense immediately all pre-contract costs unless reimbursement is assured.

The effect of the change in policy on the group’s 2001 accounts was significant. Profit before tax was reduced by £28.5 million. Together with other accounting changes introduced at the same time, this turned a £15 million profit into a loss (before tax) of £18.2 million.

Amey’s management justified the change in policy on the grounds that it was consistent with proposed UK accounting guidelines on the topic. However, the draft rules only required companies to expense immediately pre-contract costs that did not meet specified cost recovery tests. Moreover, Amey’s competitors did not change their accounting policies in 2001 and continued to capitalise certain pre-contract costs. An analyst commented at the time:

‘Amey has interpreted [the draft rules] very prudently indeed, more so than any other company has contemplated before.’

Required

(a) Under what circumstances should pre-contract costs be recorded as an asset in your view?

(b) Why do you think Amey changed its accounting policy on pre-contract costs in 2001?

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