Changes in the value of trading stock from year to year will affect the gross profits and consequently net profits of a trading business that has costs of goods sold, opening stock, and closing stock. If the closing stock for this year can be adjusted lower than last year’s closing stock, then the gross profits and net profits will be lower.
Taxpayers can value trading stock at the end of the financial year using one of three methods:
- Cost: This generally refers to the full absorption cost of an item of trading stock including the purchase price, freight costs, and overhead costs involved in manufacturing a product.
- Market selling value: This is the normal selling price of the stock.
- Replacement costs: This is the value that stock can be purchased from a normal supplier at on the last day of the income year.
The method used to value trading stock can vary year by year. In addition, different methods of valuing stock can be used for each physical item of stock, i.e. some stock items valued using cost, others market selling price, and the balance replacement costs.
The ATO requires that each business undertake an annual physical stocktake (i.e. physically inspect and value each item of stock) on the last day of the income year (30th June). As an exception to this small business entity taxpayers can choose not to account for changes in the value of their trading stock if the change is less than $5,000. That is, they just record the same opening and closing stock figures in their financial statements. This concession saves a huge amount of time for some small businesses.