A consultancy, design studio, IT support firm or cleaning company sells time, expertise or access rather than goods. That changes the bookkeeping in one important way: the invoice date and the date the income is earned often differ, sometimes by months. The chart of accounts has to handle fees, advance billing and unbilled work as three separate things.
Accounts a service business typically needs
Group income accounts by how the fee is earned, because each pattern raises different timing questions:
- Fees – projects for fixed-price or milestone work
- Fees – time and materials for hourly or daily billing
- Retainers for a fixed monthly fee for ongoing availability
- Subscription income for software access, maintenance plans or memberships
- Recharged costs for expenses passed on to clients with VAT (see below)
Alongside them, on the balance sheet:
- Deferred income (a creditor) for amounts invoiced or received before the work is done
- Accrued income (a debtor) for work done but not yet invoiced
If more than one VAT treatment applies, for instance outside-the-scope services to overseas business customers alongside standard-rated UK work, split fee accounts by VAT treatment as well.
Recognising income as the service is performed
Turnover from services is recognised as the service is delivered, measured by stage of completion, time spent or another sensible basis. Billing on a schedule that does not match the work is the norm, so the month-end question is always: how much of this have we actually earned?
Example: a project straddling year end
A web agency agrees a £15,000 fixed fee for a new site. By the 31 March year end, the agency estimates the job is 60% complete and has invoiced a £5,000 stage payment, already posted to fees. Earned income is £9,000, so a further £4,000 is accrued:
| Account | Debit | Credit |
|---|---|---|
| Accrued income | £4,000 | |
| Fees – projects | £4,000 |
The journal is reversed on 1 April, and the full invoice in May then lands in the right year. No VAT is posted on accrued income; VAT follows the invoice or payment. Our guide to unbilled revenue at period end covers estimating stage of completion.
Retainers and subscriptions billed in advance
The opposite case: a client pays a £2,400 annual support plan plus £480 VAT on 1 January. On receipt, the whole £2,400 is a liability:
| Account | Debit | Credit |
|---|---|---|
| Bank | £2,880 | |
| Deferred income | £2,400 | |
| VAT control account | £480 |
Each month, £200 is released from deferred income to subscription income. The VAT is due in full on the return covering 1 January, because payment created the tax point; only the income is spread. The mechanics, including what happens when a client cancels, are in deferred income and revenue recognition, and the balance sheet account itself is described under deferred income.
The VAT tax point for services
Revenue recognition and VAT run on different clocks. For a single supply of services:
- the basic tax point is the date the service is completed
- an earlier invoice or payment creates an actual tax point at that earlier date, to the extent of the amount invoiced or paid
- an invoice issued within 14 days after completion usually moves the tax point to the invoice date
For continuous supplies, such as ongoing support or a rolling retainer, there is no basic tax point: VAT is due on the earlier of each invoice or payment. That is why a retainer invoiced quarterly in advance puts the whole quarter’s VAT in the period of the invoice. More detail is in VAT on advance payments and tax points.
Disbursements versus recharges
Passing a cost on to a client is either a disbursement or a recharge, and the two are posted differently.
A true disbursement is a cost you pay as the client’s agent: the supply was made to the client, you paid it on their behalf, and you pass it on at exactly cost. A solicitor paying a court fee for a client is the classic case. It never touches your income or expense accounts; it goes through a disbursements control account and is outside the scope of VAT on your invoice.
A recharge is a cost you incurred to deliver your service, such as your consultant’s train fare or materials used on the job. It is part of your supply, so it goes to recharged costs income (or is netted in fees) and carries VAT at the rate of your main service, even if the original cost was zero-rated. The detail is in our guide to recharging costs to customers.
Reviewing service income each month
- Compare deferred income to the list of unexpired subscriptions and retainers; the totals should agree.
- Check that last month’s accrued income was reversed and invoiced.
- Review any account that only goes up: an ever-growing deferred income balance often means releases were never set up.
- Look at income by client against time records, which catches work that was done but not billed.
Those checks take minutes once each fee type has its own account, and they are a large part of what makes service-company management accounts worth reading.