Year end stock valuation issues

[UK Contractor Accountant]

I admire your tenacity @UK Contractor Accountant.

However I fear you won’t succeed in the face of such obstinacy. From my own experience some people just won’t listen to either common sense or technical argument, even when clearly explained. Very entertaining though!

Yep and the Earth is flat!

Think he knows he is wrong - just trying to argue it out.

 

[pentel]

I suspect that @Gyumri may be working on using cash basis accounting.

There are restrictions for this:

Cash basis

Small businesses can record income and expenses when money is actually paid rather than when they've invoiced or received

www.gov.uk

 

[Argentum Tax]

I suspect that @Gyumri may be working on using cash basis accounting.

There are restrictions for this:

Maybe, but we are talking about a company here, and cash basis cannot be used for Corporation Tax unfortunately.

 

[pentel]

Maybe, but we are talking about a company here, and cash basis cannot be used for Corporation Tax unfortunately.

Perhaps they have being using this basis in error, who knows?

 

[Argentum Tax]

Perhaps they have being using this basis in error, who knows?

I think that’s possible. The OP did say at the outset that he wanted to “more fairly calculate our year end stock valuation.”

The accountants here were trying to explain to the OP the correct way to value stock, in accordance with the law and relevant accounting standards, and how it has a knock-on effect on profits and hence Corporation Tax.

It does nothing to help, and simply confuses the issue, when someone here is trying to make out that nothing is wrong and stock values don’t matter anyway because they don’t affect profits. Any accountant or bookkeeper will tell you that is patently wrong, and it continues to be wrong no matter how many times someone repeats their nonsense.

Rant over!

 

[Ziggy2024]

Well, after all that, I feel my understanding of the effects of closing stock valuation on CT was, and still is, correct, though my understanding of why this is so is far simpler than the explanation from the accounting professionals.
Up until previous year end (2023) I'd always used an 'average stock valuation' report, which calculated the valuation based on each historic purchase and current cost. I wasn't over confident in this figure but it was the best option available. As referenced in several posts on this thread, I'd at least been consistent with this approach.
The downfall of the new system I'm using is the lack of flexibility when reporting stock valuation. The only figure available is current cost multiplied by quantity.

Without wanting to cause any further argument; does my earlier suggestion of taking an average of 2023 and 2024 closing stock valuation figures and making a small adjustment for depreciation, perhaps 2%, seem sensible?

Thanks for all the input, I've learned quite a bit from this thread.
Kind regards
Rob

Yes you could do the average. I think in your position, if new software is out of the question, I would do regular valuations (say at least once a quarter) and use a spreadsheet to get an average cost over the year. Not ideal, but may give a more consistent value.

 

[Ziggy2024]

I suspect that @Gyumri may be working on using cash basis accounting.

There are restrictions for this:

If that were the case there wouldn't be a stock value on the balance sheet.

Its possible that Gyumri has been preparing their accounts wrong. It could be that they have an accountant who has correctly prepared their business accounts but this has not been understood.

Common sense has been mentioned multiple times on this thread. It's a nice concept but can be irrelevant in terms of accounting standards. Double entry and accruals (matching) concept are very basic accounting standards as has already been stated but accountants often forget that these concepts can be difficult to grasp when you're not using them constantly.

 

[Rob-Ed]

Yes you could do the average. I think in your position, if new software is out of the question, I would do regular valuations (say at least once a quarter) and use a spreadsheet to get an average cost over the year. Not ideal, but may give a more consistent value.

That sounds like a plan. Thanks Ziggy.

 

[DontAsk]

"Cost of sales" should never include a valuation of stock at the year but rather on what the actual cost of purchase of that stock has been.

So if in Year 1 you buy £2 worth of stock and sell £1 worth by the year end you've made a profit of £1.

In year 2 if you buy no extra stock your cost of sales will be nil. Your "cost of sales" will not be £1, or whatever value you want to put on your remaining stock.

The value of your remaining stock in year 2 might still be £1, but your cost of sales will still be zero for year 2.

The value of £1 will be shown on the balance sheet but it will not be shown on the P&L for obvious reasons.

This is plain commonsense and is not worth further debate.

Explain what happens, during an accounting period, when stock you are holding has to be revalued for some reason. This is the concept in the 2nd post "Stocks should be valued at the lower of cost or net reliable value (NRV)." [should be realisable value]. Lets say it becomes obsolete and the NRV is less than you paid for it.

What effect does that have on closing stock? What effect does that have on profit?

 

[Scalloway]

What effect does that have on closing stock? What effect does that have on profit?

The value of closing stock is reduced, reducing gross profit and consequently net profit.

 

[DontAsk]

The value of closing stock is reduced, reducing gross profit and consequently net profit.

Yes, I know that. Gyumri is the one who doesn't seem to get it.

 

[Gyumri]

Are you of the opinion that the AAT study material is wrong?

Yes I am. It's idiotic. CT is calculated and always has been on what profit a company makes in a particular financial year. There is no such basis called an "accrual" basis for calculating CT.

What you buy in a particular year and what you sell determines your taxable income in any particular year.

There is no place for valuing stock in the P&L. The cost of sales is purely and simply what you expend in any particular year on selling your products. That could include research and development costs.

The retained profits are of course carried forward on the balance sheet.

 

[Gyumri]

The value of closing stock is reduced, reducing gross profit and consequently net profit.

And where do you see that entry in any P&L? Gross profit is simply sales less cost of sales - a stock valuation doesn't come into it.

"Cost of sales" has nothing to do with the value of your stock - but what you paid for it.

If you paid nothing in year 2 but still have a closing stock left of £1 million which you bought in year 1, your costs of sales in year 2 is nil - it isn't £1m!

 

[Scalloway]

Gross profit is simply sales less cost of sales

You may not see the calculation on the accounts but cost of sales is opening stock plus purchases less closing stock. That is the cost of the goods actually sold in the year.

 

[Ziggy2024]

Yes I am. It's idiotic. CT is calculated and always has been on what profit a company makes in a particular financial year. There is no such basis called an "accrual" basis for calculating CT.

What you buy in a particular year and what you sell determines your taxable income in any particular year.

There is no place for valuing stock in the P&L. The cost of sales is purely and simply what you expend in any particular year on selling your products. That could include research and development costs.

The retained profits are of course carried forward on the balance sheet.

With all due respect you are making yourself look a little silly here.

A quick Google will tell you that accruals basis (or matching concept) is a fundamental accounting concept and is mandatory for incorporated entities. The other fundamental aspect of accountancy is that every entry has an equal and opposite entry. If you change a balance sheet figure there is an opposite entry, often this will be the profit & loss account.

Cost of sales is matched to the sales within the accounting period. The way this is accounted for is to remove the cost of any unused stock and hold it in the balance sheet to be matched against future sales. It is accounted for at cost but if you have to impair the value (if the stock is obsolete or damaged) your accounting entry is Dr P&l Cr BS. This entry will reduce the taxable profit (used to calculate the corporation tax).

As others have said this is a concept that all bookkeepers and accountants have to learn in order to do their job. Dismissing the guidance of a UK accountancy professional body as idiotic is also not very sensible.

 

[NortonBishop]

............What you buy in a particular year and what you sell determines your taxable income in any particular year.......

So if my company buys a car for £10k in year 1 and sells it for £15k in year 2, you would say that in year 1 the company made a loss of £10k and in year 2 it made a profit of £15k?

(the correct answer is that the company made no profit in year 1 and made £5k in year 2)

 

[DontAsk]

And where do you see that entry in any P&L? Gross profit is simply sales less cost of sales - a stock valuation doesn't come into it.

"Cost of sales" has nothing to do with the value of your stock - but what you paid for it.

If you paid nothing in year 2 but still have a closing stock left of £1 million which you bought in year 1, your costs of sales in year 2 is nil - it isn't £1m!

Do keep digging. It's entertaining

 

[UK Contractor Accountant]

Roll over AAT the future of book-keeping is here!

Single entry transactions but still able to get a balanced trial balance. Not sure how the likes of Sage, QuickBooks, FreeAgent, Xero are going to handle this but its going to be fun seeing how they reprogram their software.

 

[Gyumri]

You may not see the calculation on the accounts but cost of sales is opening stock plus purchases less closing stock. That is the cost of the goods actually sold in the year.

What you are describing is not cost of sales but the assets of the company.

Let's make it simple :

Year 1: You buy 10 plastic ducks at £1 each. Your cost of sales = £10.
You don't sell any ducks.

Year 2 you buy another plastic duck at £1. You still don't sell any ducks.
Your cost of sales = £1.

Your cost of sales for year 2 is NOT opening stock of 10 ducks + purchase of 1 duck = 11 ducks less closing stock of 11 ducks = cost of sales £0

Your cost of sales is the price of the single duck ie., £1

 

[Gyumri]

To continue:

Year 3 you sell 1 duck for £5.
your cost of sales is not opening stock of 11 ducks less closing stock of 10 ducks = 1 duck ie., £1
Your cost of sales is actually £0

That is because you have already paid for the ducks in years 1 and 2.

CT is calculated with respect to each financial period.

The OP should not therefore worry about the basis for valuing his stock at any point in time for CT purposes but simply calculate CT on the basis of what he has paid and what he has sold in any particular financial period.

 

[LPB 123]

What you are describing is not cost of sales but the assets of the company.

Let's make it simple :

Year 1: You buy 10 plastic ducks at £1 each. Your cost of sales = £10.
You don't sell any ducks.

No, your cost of sales is £0.

Year 2 you buy another plastic duck at £1. You still don't sell any ducks.
Your cost of sales = £1.

No, your cost of sales is £0.

To continue:

Year 3 you sell 1 duck for £5.
your cost of sales is not opening stock of 11 ducks less closing stock of 10 ducks = 1 duck ie., £1
Your cost of sales is actually £0

No, your cost of sales is £1.

You're describing cash basis accounting where you are expensing stock as you purchase it. This method is not available to companies.

 

[numbersrule]

"Cost of sales" should never include a valuation of stock at the year but rather on what the actual cost of purchase of that stock has been.

So if in Year 1 you buy £2 worth of stock and sell £1 worth by the year end you've made a profit of £1.

So let's say you had no stock before this that would mean:
End of Year 1
P&L
Sales £2
Opening Stock £0
Purchases £2
Closing Stock £1
Cost of Sales £1
Gross Profit £1
Balance Sheet

Assets
Stock £1

Equity
Retained Profit £1

In year 2 if you buy no extra stock your cost of sales will be nil. Your "cost of sales" will not be £1, or whatever value you want to put on your remaining stock.

The value of your remaining stock in year 2 might still be £1, but your cost of sales will still be zero for year 2.

The value of £1 will be shown on the balance sheet but it will not be shown on the P&L for obvious reasons.

End of Year 2
P&L
Sales £0
Opening Stock £1
Purchases £0
Closing Stock £1
Cost of Sales £0
Gross Profit £0
Balance Sheet

Assets
Stock £1

Equity
Retained Profit £1

This is plain commonsense and is not worth further debate.

 

[Ziggy2024]

What you are describing is not cost of sales but the assets of the company.

You appear to be mixing up your profit & loss and balance sheet. In your examples the stock would be on the balance sheet because there are no sales. You don't recognise the purchase in your profit & loss until you can match it to a sale.

Your stock on the balance sheet would be:
Year 1 - £10
Year 2 - £11
Year 3 - £10

To complete your examples the CT on all your years would be calculated on the following figures:
Year 1 - NIL (not a loss)
Year 2 - NIL (not a loss)
Year 3 - £4

This is the basis on which a company MUST calculate their profit.

 

[NortonBishop]

This is the basis on which a company MUST calculate their profit.

Apart from it being the required way, the normal way, the accepted way and the statutory way of doing it, it's also common sense and how the calculation would be done in everyday conversation.

If you have a friend who owns a garage and you ask her, "how much did you make selling that car?" she is unlikely to say, "actually it was a really good deal - I made a 100% profit because I bought it in the last accounting period" or, "I made a loss because I bought some other cars this week".

They are more likely to say, "I bought it last year for £10k, sold it for £15k so made £5k"

 

[Ziggy2024]

Apart from it being the required way, the normal way, the accepted way and the statutory way of doing it, it's also common sense and how the calculation would be done in everyday conversation.

If you have a friend who owns a garage and you ask her, "how much did you make selling that car?" she is unlikely to say, "actually it was a really good deal - I made a 100% profit because I bought it in the last accounting period" or, "I made a loss because I bought some other cars this week".

They are more likely to say, "I bought it last year for £10k, sold it for £15k so made £5k"

Agreed.

 

[UK Contractor Accountant]

Interestingly from 6 April 2024 cash basis is the default for sole traders & partners.

You now have to actually opt out if you want to use Accruals accounting.

 

[Scalloway]

What you are describing is not cost of sales but the assets of the company.

After 50 years as an accountant I finally discover I've been doing it wrong all along.

 

[Ziggy2024]

Interestingly from 6 April 2024 cash basis is the default for sole traders & partners.

You now have to actually opt out if you want to use Accruals accounting.

I suspect a lot of tax returns have unwittingly been prepared on that basis anyway, don't you? I'm undecided whether this is a good thing or a bad thing really.

 

[UK Contractor Accountant]

I'm undecided whether this is a good thing or a bad thing really.

HMRC have scrapped the turnover limit for operating the cash basis so as mentioned above taxpayers sitting on a rather hefty taxable profit for the year can just plough a fair chunk of the profits into stock on the last day of the financial year and avoid paying large tax bills.

Adds a whole new dimension on tax planning and stock levels at year end - if you are into the higher rates of tax, for example, you might just invest enough in stocks to bring your taxable profits down to the basic rate tax threshold.

At some stage it will unwind when you have to release those stocks back for resale and bring stock levels back down.

 

[DWS]

HMRC have scrapped the turnover limit for operating the cash basis so as mentioned above taxpayers sitting on a rather hefty taxable profit for the year can just plough a fair chunk of the profits into stock on the last day of the financial year and avoid paying large tax bills.

Adds a whole new dimension on tax planning and stock levels at year end - if you are into the higher rates of tax, for example, you might just invest enough in stocks to bring your taxable profits down to the basic rate tax threshold.

At some stage it will unwind when you have to release those stocks back for resale and bring stock levels back down.

Deleted, apologies

 

[Gyumri]

To continue:

Year 3 you sell 1 duck for £5.
your cost of sales is not opening stock of 11 ducks less closing stock of 10 ducks = 1 duck ie., £1
Your cost of sales = £0

That is because you have already paid for the ducks in years 1 and 2.

CT is calculated with respect to each financial period.

The OP should not therefore worry about the basis for valuing his stock at any point in time for CT purposes but simply calculate CT on the basis of what he has paid and what he has sold in any particular financial period.

 

[Gyumri]

In simple terms, the cost of sales/cost of goods sold is opening stock plus purchases in the year less closing stock.

Let's keep it simple:

You buy 10 plastic ducks for £1 each (your opening stock) and sell 5 at £5 each. Your closing stock is 5 ducks.

Your cost of sales is not opening stock less closing stock = 5 ducks. Your cost of sales is 10 ducks ie., £10. Your profit is £25 less £10 spent on buying ducks.

I suspect that @Gyumri may be working on using cash basis accounting.

It makes no difference whether your accounts are completed on an accrual basis or a cash accounting basis.

So if my company buys a car for £10k in year 1 and sells it for £15k in year 2, you would say that in year 1 the company made a loss of £10k and in year 2 it made a profit of £15k?

(the correct answer is that the company made no profit in year 1 and made £5k in year 2)

The correct answer is your first statement: you made a loss of £10,000 in year 1 which you can carry forward to year 2. In year 2 you made a profit of £15,000 which you can set against your loss made in Year 1 = £5,000 taxable profit.

 

[Gyumri]

You appear to be mixing up your profit & loss and balance sheet. In your examples the stock would be on the balance sheet because there are no sales. You don't recognise the purchase in your profit & loss until you can match it to a sale.

The P& L simply records sales against purchases - even if you don't make any sales you still record your purchases there! (where else?)

If you buy 1 plastic duck for £1 then that is your current asset on the balance sheet and the purchase is shown on the P&L.

The P& L is a standalone schedule of income and expenditure and the retained profit after tax and dividends is shown on the balance sheet as retained earnings.

That's my understanding. Am I missing something?

 

[Ziggy2024]

The P& L simply records sales against purchases - even if you don't make any sales you still record your purchases there! (where else?)

If you buy 1 plastic duck for £1 then that is your current asset on the balance sheet and the purchase is shown on the P&L.

The P& L is a standalone schedule of income and expenditure and the retained profit after tax and dividends is shown on the balance sheet as retained earnings.

That's my understanding. Am I missing something?

Yes, as I noted before you are missing the 2 fundamental concepts of accruals (matching) and double entry. If the plastic duck is on the balance sheet as stock, it has been removed from your calculation of profit. You only recognise (match) the cost of the item in the p&l when you sell it.

The p&l is not standalone, it is inextricably linked with the balance sheet.

 

[Ziggy2024]

Let's keep it simple:

You buy 10 plastic ducks for £1 each (your opening stock) and sell 5 at £5 each. Your closing stock is 5 ducks.

Your cost of sales is not opening stock less closing stock = 5 ducks. Your cost of sales is 10 ducks ie., £10. Your profit is £25 less £10 spent on buying ducks.

It makes no difference whether your accounts are completed on an accrual basis or a cash accounting basis.

Using your example cash basis would give a profit of £15. Accruals basis would give a profit of £20. As a company you have to use the accruals basis to prepare your accounts.

 

[David Griffiths]

Let's keep it simple:

You buy 10 plastic ducks for £1 each (your opening stock) and sell 5 at £5 each. Your closing stock is 5 ducks.

Your cost of sales is not opening stock less closing stock = 5 ducks. Your cost of sales is 10 ducks ie., £10. Your profit is £25 less £10 spent on buying ducks.

That is completely wrong. The other term for "cost of sales" is "cost of goods sold" and that may help you understand the position. You have sold 5 ducks, for £25 and the cost of those 5 ducks is £5. Your profit on those sales is therefore £20. By conventional methods, which you appear to deny, the cost of sales comes from purchases of £10 less unsold stock of £5..

Like Scalloway before I have been doing this for a long time and your approach, under accruals accounting is categorically wrong.

 

[Gyumri]

"cost of sales" is "cost of goods sold"

Please don't tell the tax man that!

Your costs of sales in any particular financial period is what you have paid out to manufacture or purchase the goods that you intend to sell - irrespective of whether you actually sell any goods.

That is why many companies make a loss in their first years of business - they have spent more on acquiring or producing goods than they are able to sell.

If cost of sales simply means costs of goods sold as you say, then no company would ever make a loss in selling goods.

The OP's question is about valuing his stock and believes that the value of his stock will somehow impact upon the CT he may have to pay.

I have said that however he wishes to value his stock or whatever it is deemed to be worth, is totally irrelevant to CT.

Using an example given above of a company buying a car for £10,000 - the value of that car whilst it remains as unsold stock might have diminished or increased in value by the time it is sold - but that value has no bearing on what CT will be paid when the car is sold. CT will be determined solely by the profit if any made on the sale.

 

[Scalloway]

Words fail me.

 

[UK Contractor Accountant]

@Gyumri

Have a read and then come back to us with your thinking why AAT & HMRC are wrong on stocks affecting profit/loss and Ctax.

BIM33110 - Stock: valuation: tax treatment of trading stock - Lord Nolan in Threlfall v Jones - HMRC internal manual - GOV.UK

www.gov.uk

Hold your hand up high, be a man and admit you are wrong on this one.

 

[NortonBishop]

It's interesting how complete mistruths might gain traction.

I don't want to make this personal but people could be misled.

Gyumri is stating things that are completely wrong from a legal, bookkeeping, accounting and - in my opinion - logical, point of view.

Does anyone here read his / her comments and believe them to be true on this subject?