Stock Valuation & HMRC

[scarletsignal]

Hi All,

To manage our stock we currently use weighted average as it's the only method supported by our system. From our point of view this is OK, however I wonder whether HMRC would have any opinion on the method we use?

I suppose that given the type of products we sell FIFO would be a more accurate method but I'd rather not go through custom implementation of this feature in our system if I can avoid it.

I haven't found a lot of articles / material on the web to explain HMRC position on this, which makes me believe I'm over-thinking... Somehow I struggle to believe that HMRC would go through the pain of assessing in detail our stock valuation method especially as our turnover is far from significant

 

[MrAnchovy]

FIFO and Average Cost are equally acceptable in tax law in the UK.

HMRC do have some fairly extensive internal guidance on stock valuation.

 

[scarletsignal]

Thanks for confirming.

I did go through that section however as it refers to: "lower of cost and net realisable value" and "mark to market" I wasn't entirely sure how these related to weighted average, actually both seem alternative methods to be used in case of liquidation or unsold stock where assessing the fair stock value cannot just be based on price (as being undersold).

I couldn't find anything in the HMRC site relating to FIFO and average cost other than a more technical article comparing LIFO to FIFO.

To be honest whilst there is quite a lot of material on the web to explain theory and application of different valuation methods I find the HMRC section quite hard to decipher, but may be it's just me

 

[faradaykeynes]

What kind of stock are we talking about? Any overhead cost allotment involved?

 

[scarletsignal]

Spare items.

Just to give you an example, say we sell coffee mugs.

We make supply orders for one or more designs, all similar in price. The cost of the goods plus shipping, customs, VAT (as we're not registered yet), agent admin fee, all go into the STOCK account to then be accounted as COGS n proportion to each item.

The way we do this in the system is to calculate the overall cost for each order (all the above included), split it equally amongst the items in that order which in turn affects the average cost of that particular product. When sold its current average cost is moved in the COGS account.

 

[faradaykeynes]

FIFO or Avg cost is recommended method to value closing stock. Any thing going into COGS need not be per unit cost element for stock price

 

[scarletsignal]

Any thing going into COGS need not be per unit cost element for stock price

Not sure I see what you mean here, if I want to post COGS related to the item/items I just sold I need to know what proportion of the costs has been sold, the only way to do this I can think of is to assign to the stock item value a cost including all its COGS and then post this value into the COGS account at the time of sale. Is there another way to post COGS movements?

 

[faradaykeynes]

COGS makeup and stock valuation unit cost makeup are two different things, e.g if you make marketing guys and part of there cost you treat as COGS that should not increase per unit item cost for stock valuation.

Best is record cost in several nominal codes and categories them as direct or indirect nominals, that will save you doing lot of journal entries and every time you generate report from your account software you will idea of COGS and over all profit

 

[MrAnchovy]

Is there another way to post COGS movements?

Yes.

Do not make any entries to COGS when you make a sale. Instead post all costs relating to stock to COGS. At the end of the period, count the items in stock and value them. Credit COGS and debit Stock with the closing stock value; reverse this transaction at the beginning of the next period.

This method tends to be favoured by financial accountants who only care about what the accounts show at the end of the period. It also often means in practice that stock is valued on a basis that falls between FIFO (or more accurately, LILO which is the same thing) and Replacement Cost - because each item is valued at whatever it cost on the most recent invoice (unless there is a sophisticated system in place such as unit bar coding)

The management accountant prefers accounts that make sense all the time and so makes cost of sales entries against each sale (or batch of sales). The only practical way to do this (again unless there is a sophisticated system in place such as unit bar coding) is to use Average Cost.

Financial accountants who do not understand this may make a "Physical Stock Adjustment" at the end of each period "correcting" this to FIFO or the 8a5tard son of FIFO and Replacement Cost mentioned above.

 

[faradaykeynes]

that is right if operation involves complex manufacturing process but then if that is the case then you would need a cost and management accountant on board with cost accounting system in place and separate financial accounting system

 

[scarletsignal]

Do not make any entries to COGS when you make a sale. Instead post all costs relating to stock to COGS. At the end of the period, count the items in stock and value them. Credit COGS and debit Stock with the closing stock value; reverse this transaction at the beginning of the next period.

Doesn't this produce the same result as posting stock item value at every sale and all costs relating to stock straight to COGS?
As I'm using a real-time stock valuation and I'd like to keep it that way the stock-value posting is the easy part, the hard one is the 'other costs' dealing with acquisition as I can't easily relate them to each sale - from your explanation however and other reading it seems to me that these 'other costs' are posted at the end of every period regardless of the amount of stock sold which would make my life a lot easier.

 

[faradaykeynes]

For stock valuation you need two things, number of items in stock and unit cost. Number of stock item is easy you can count, unit cost is some thing you need to pay attention. Lets say you do FIFO basis, you would work out unit cost with each consignment and keep record of it. Unit cost for stock would include purchase price, shipping, any other cost essential to bring the stock to warehouse, once stock reaches there, if you are not doing any further processing then your stock unit cost should not change for that particular consignment.

Any further cost to actually make sale would be direct and indirect expenses. Based on your classification in accounting software you can find out COGS and record direct expenses as they incur instead of allocating it at point of sales.

I dont see a point of following a comprehensive cost accounting system here

 

[scarletsignal]

Thanks I think I got it now. As you noticed the difference between invoice value and COGS was the concept that I wasn't quite grasping... I guess I had to sleep on it

 

[faradaykeynes]

Glad to be of help, with COGS as a whole , unit price for stock would be higher thus incorrect stock valuation. This link has a good basic example to expand on concept , hope you will be mega clear after reading it http://www.investopedia.com/articles/02/060502.asp#axzz2FrmNe6TO