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Unformatted text preview: ACIS 254: ACIS Introduction to Taxation Introduction
Lecture 27: Trading Stock
Department of Accounting & Department Information Systems, University of Canterbury, Christchurch Christchurch 1 Trading Stock - Introduction
• For any business, especially manufacturers, For
distributors or retailers, methods chosen to record and value trading stock on hand at year-end have a major impact on the bottom line profit. major • Before the 1998/99 income year, the rules Before governing income from trading stock were a combination of statute law, case law and Inland Revenue Department practice. Revenue • This could lead to conflict between the position This
taken by the taxpayer and that adopted by the Department. Department.
2 Introduction (continued)
• Tax is calculated on the net income figure. By Tax
minimising the value of trading stock on hand at year-end, the deduction for cost of goods sold is maximised and the resulting tax liability reduced. Taxpayers could value their stock for tax purposes Taxpayers at cost price, market selling value or replacement price. price. This freedom to choose gave considerable scope This for spreading or deferring taxable income between income years.
3 • • Recent Developments and Reforms • April 1997 – Discussion document outlining April proposals for reform. proposals • Improving the coherence of income tax law by Improving codifying the tax rules that apply to trading stock, reducing compliance costs. stock, • No major review of trading stock rules since No their original enactment in the Land and Income Tax Amendment Act 1939. Income
4 From the 1998 – 1999 income tax year • Trading stock must be valued at cost for income Trading • • • • tax purposes. tax Discounted selling price or market selling value Discounted may be used if they are used in the taxpayer’s financial statements. financial Generally market selling value may also be used if Generally it is lower than cost. it Trading stock valuation rules now more closely Trading follow financial reporting requirements Exception to the general rule – low-turnover trader Exception (turnover of less than $3million per annum). (turnover
• Company renovates washing machines & refrigerators for resale. Company
Year to 31/3/08, opening stock $40,000, & closing stock $65,000. Annual sales $90,000, & $30,000 spent on acquiring old units, $35,000 on renovation labour & $2,000 on new parts during year. $35,000 • Gross trading income: Opening stock 40,000 Sales Opening Sales Purchases 30,000 Closing stock Closing Direct labour 35,000 Parts 2,000 Gross profit 48,000 48,000 155,000 90,000 65,000 . 155,000
6 (Value of closing stock is income for the income year, opening value (and purchases (Value during the year) are allowable deductions) during Trading stock defined
• Trading stock is defined in s EB 2 ITA 2007. • The valuation of livestock is dealt with in subpart The
EC and is not examinable in this course. not • 22(1) Tax Administration Act 1994 obligation to 22(1) keep records. keep When – When a taxpayer’s business involves dealing in goods sufficient details relating to the value and quantity of stock, purchases and sales must be maintained. stock, 7 Trading Stock (continued)
• Items produced, manufactured, acquired for the Items • • • •
purpose of manufacture, sale or exchange. purpose Does not include land. Includes work in progress, raw materials Must be included in accounts if the taxpayer is in Must business. business. Taxpayers in business must take annual variations Taxpayers in trading stock into account in calculating income. income.
8 Trading Stock Includes/ excludes: • Car dealers -motor vehicles on the shop floor Car • • • • • •
are trading stock of the dealer. Crops not included (part of the land, but Crops profits on sale are taxable). Land (only if taxable under s. CB 6- CB 23). Livestock not used in a dealing business is Livestock excluded. excluded. Shares (when the person is a dealer). Shares Excludes consumable aids & most spare parts. parts. But includes containers, packaging, labels, But etc. etc. 9 Valuation of Trading Stock from 1998 / 1999 • Subpart EB Income Tax Act 2007 sets out the Subpart
rules for valuation. rules • More closely aligned with financial reporting More requirements. requirements. • The rules are divided into two categories:
Rules – Rules for ‘low-turnover traders’ (formerly referred to as ‘small’ taxpayers. to – Rules for other taxpayers. 10 10 Valuation of Trading Stock from 1998 / 1999 (continued) • Definition of ‘trading stock’ was clarified – limited Definition • • to a business undertaking and linked to a purpose of selling or exchanging trading stock in the course of the business. the Trading stock must now be valued using a cost Trading valuation method (i.e. cost, discounted selling price, replacement price) or if market selling value is lower than cost, may be used. than Four methods referred to as the standard valuation Four methods.
11 11 Standard Valuation Methods 1. 2. 3. 4. Cost Replacement Price Discounted Selling Price Market Selling Value 12 12 Standard Valuation Methods • Cost: • Must be in accordance with Generally accepted Must • • • accounting practice (GAAP). accounting NZ IAS 2: Inventories. NZ Inventories. Taxpayers do not have to incur additional compliance Taxpayers costs preparing separate tax valuations. costs The value of closing stock is adjusted for any The variance between actual costs incurred and costs budgeted for. budgeted
13 13 Standard Valuation Methods (continued)
Is – Is the market value (excluding GST) for acquiring the equivalent trading stock on the last day of the income year. year. Discounted Selling Price
could, – could, depending on the business of the taxpayer, be retail sale price less normal gross profit margin. retail (These methods may be used to approximate cost if they (These are used for financial reporting purposes). are axpayer • A ttaxpayer who values closing stock at cost, discounted selling price or replacement price must comply with consistency requirements. comply
14 14 Standard Valuation Methods
Market Selling Value
Broadly – Broadly the amount that a taxpayer would normally expect to receive in the ordinary course of business (i.e. selling price). of Certain – Certain direct selling costs may be deducted in calculating market selling value if they have been taken into account for financial reporting purposes. taken There – There is no longer the ability for provision for obsolete or slow moving stock to allow a lower closing stock figure. closing Market – Market selling value should allow for obsolescence. obsolescence.
15 15 Low-turnover traders • Simplified rules for low-turnover traders. • Defined as those who, together with associates, Defined • •
have an annual turnover of $3 million or less - see ss. EB 13(2) ITA 2007. ‘Turnover’ means – total income that a business Turnover’ derives in an income year as a result of trading, excluding closing stock. excluding For stock valued at cost, low turnover traders may For calculate the value either in compliance with generally accepted accounting practice or using simplified valuation rules specific to low-turnover traders – see EB 15 to EB 21 ITA 2007. traders
16 16 Low-turnover traders • Low-turnover traders do not need to account Low-turnover • •
for variances between budgeted and actual cost of trading stock. of Replacement price and discounted selling price Replacement are options available whether or not the taxpayer prepares financial statements. If they do prepare financial statements can If only use one of these methods if it has been used in the financial statements. 17 17 Low-turnover traders • May use market selling value for stock that has May
a value lower or higher than cost, if they do so higher from year to year consistently. from • Taxpayers (including low-turnover traders) Taxpayers whose turnover in an income year does not exceed $1.3million, and whose closing stock is estimated to be less than $10,000, may value their closing stock at the same value as their opening stock [s EB 23 ITA 2007].
18 18 Valuation method • The same valuation method does not have to The
be used for all trading stock held by a taxpayer. taxpayer. axpayer • A ttaxpayer may use cost for some stock and market selling value for other stock. market • Inland Revenue expects that taxpayers will Inland apply the same valuation method to groups of similar or related items of trading stock.
19 19 Consumable Aids
• Excluded from trading stock definition. • For financial reporting purposes consumable For
aids are included in the cost of inventories. aids • Consumable aids not defined in ITA 2007. Items or materials: Items
1. In a short time either wholly or 1. In almost wholly consumed in the process; and almost 2. Do not become component parts of Do finished product. finished 3. Used in the manufacture or production of goods; Used
20 20 Consumable Aids (continued)
• Typical examples include fuel and oil. Typical • Consumable aids does not include containers, Consumable • • •
packages & labels – these are trading stock. packages Consumable aids are allowed as a deduction s. DA Consumable 1(1) – as they are not trading stock. 1(1) If large amount is retained, e.g. 10 years supply If capital stock and no immediate deduction (s EA 3 ITA 2007). Furnace bricks consumable aids even though 16 Furnace months supply held.
21 21 Consumable Aids and Spare Parts
• If the cost of all consumable aids on If
hand at year end does not exceed $58,000 - immediate deduction is $58,000 permitted. permitted. If balance on hand exceeds $58,000 – no If $58,000 deduction allowed in that year – item must be capitalised and reduced as materials utilised – see s EA 3 ITA 2007. materials $58,000 is the critical figure to be aware $58,000 of in respect of consumable aids. of
22 22 • • Consumable Aids and Spare Parts Consumable (continued) (continued)
Non-trading stock split into: (1) Consumable aids: stationary or cleaning materials relating to (1) process of production; and (2) Items of unused plant or equipment: spare motors which relate to means of production or operation. relate Note: • Spare parts are excluded from the definition of trading stock Spare for tax purposes, unless held for sale or exchange in the ordinary course of business. ordinary • Spare parts held for fulfilling warranty requirements are Spare trading stock, because they are held for exchange. trading • Replacement elements & containers, packaging etc are trading Replacement stock. stock.
23 23 Key Points - Trading Stock
• • • • • •
Developments and reforms. Trading stock defined. Standard valuation methods – (cost, discounted selling price, Standard replacement price) and market selling value. replacement Cost valuation method unless market selling value is lower Cost than cost. than NZ IAS 2 definitions and disclosure requirements. Low turnover traders:
– Reduction in compliance costs is possible. • Consumable aids (as defined) are not trading stock. • Spare parts.
© Alistair Hodson 24 24 ...
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