As we come to the end of the financial year ended 31 March 2020 and you start preparing your records to send to us to begin preparing your financial statements, a prevalent issue for businesses carrying stock is how it will be valued for accounting and tax purposes. We’ve created a summary of important points around trading stock to consider and keep in mind in your approach to inventory valuation.
The tax treatment of your trading stock has a big impact on your bottom line. Unlike other revenue expenses, a deduction for trading stock is only allowed at the time the stock is sold. Trading stock is required to be valued at the end of each financial year in order to recognise fluctuations in the value and to calculate your assessable income.
What is Trading Stock?
Trading stock is property that a taxpayer holds for the purpose of selling or exchanging in the ordinary course of their business.
What does Trading Stock include and exclude?
Trading stock includes partly completed work that would be trading stock if completed (WIP), materials held for producing trading stock (raw materials), certain property leased under a hire purchase agreement, and stock purchased but not yet delivered at balance date. It excludes land, depreciable property, consumable aids used in producing stock, and parts not held for exchange or sale
Why is Trading Stock significant?
The calculation is simple and straightforward:
Opening stock value = deduction
Closing stock value = income
If your opening stock exceeds closing stock, you have a net deduction, if your closing stock exceeds opening stock you have net income. Your closing stock at year-end represents an asset, this value becomes the opening balance for the following year’s stock, thus the significant exercise is determining the value of your closing stock.
How do I value Trading Stock?
There are four standard valuation methods that can be used; cost, replacement price, discounted selling price and market selling value. Variations to these methods apply to low turnover traders, and a special concession applies to low turnover traders who meet specific criteria. A low turnover trader is a taxpayer whose annual turnover does not exceed $3 million. If you are a low turnover trader and your turnover is less than $1.3 million, and the value of your closing stock is reasonably estimated to be less than $10,000, you can value your closing stock as the opening value.
What if Trading Stock gets disposed of, lost or destroyed?
Any disposal for inadequate consideration, that is an amount below market value or for no consideration, will be treated as being disposed of at market value. Disposals outside the ordinary course of business such as the passing of property by means of exchange or gift, or by changing the use in stock to become business assets, will also be treated as a disposal at market value. If business owners use trading stock for private purposes, the stock is treated as being sold at market value.
Stock that gets lost or destroyed in the current financial year will be valued at nil as a deduction would be claimed under purchases. Insurance and compensation payments received for the loss of stock is income to the extent that a deduction could have been claimed for the cost of the stock.
It is important to consider the impact of trading stock on your gross profit. Knowing where to start and how to interpret the New Zealand tax system can be a tricky task. For guidance on what method to use and how to apply the method to your situation, we recommend seeking professional advice. The team at Giles and Liew Chartered Accountants are happy to assist you in this task. Let us take care of the numbers while you take care of your business.