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HMRC internal manual

Business Income Manual

Stock: valuation: lower of cost and net realisable value: cost

One of the acceptable bases of stock valuation is the lower of cost and net realisable value. The meaning of cost is discussed below and net realisable value is at BIM33140.

In general, the term ‘cost’ should be interpreted as meaning the total historical cost of bringing the relevant stock to its existing condition and location; and where this is not precisely ascertainable, the aim should be to arrive at the closest approximation to historical cost that is practically attainable.

Additional rules may be found in SI 2008 No 409 and SI 2008 No 410. In both these SIs, Sch1, Para27 provides:

  1. The purchase price of an asset shall be determined by adding to the actual price paid any expense incidental to its acquisition.
  2. The production cost of an asset shall be determined by adding to the purchase price of the raw materials and consumables used the amount of the costs incurred by the company which are directly attributable to the production of that asset.
  3. In addition there may be included in the production cost of an asset - ‘A reasonable proportion of the costs incurred by the company which are only indirectly attributable to the production of that asset but only to the extent that they relate to the period of production ……’. Also, interest on capital borrowed to finance the production of that asset may be included, to the extent that it accrues in respect of the period of production and provided that the inclusion of such interest is noted in the accounts.

Thus, where expenditure is properly classified as within paragraph 27, its inclusion, denoted by the words ’is to be determined’, is mandatory whereas in paragraph 27(3) the use of the word ’may’ merely permits the company to include expenditure of a type therein described.


Overhead charges, if any, should be included in cost to the extent that is appropriate having regard to generally accepted accounting practice.

Overheads are classified, under section 13 of FRS102, as fixed or variable according to whether or not they remain constant regardless of the volume of production.

Examples of fixed production overheads include depreciation and maintenance of factory buildings and equipment, and the cost of factory management and administration. Fixed production overheads are allocated to the cost of stock on the basis of normal capacity i.e. the production expected to be achieved on average over a period of time. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of low production. However, in periods of high production, it may be necessary to reduce the amount of fixed overhead allocated to each unit of production in order to ensure that stock is not measured at above actual cost.

Examples of variable production overheads include indirect materials and indirect labour that vary directly, or nearly directly, with the volume of production. Variable production overheads are allocated to each unit of production on the basis of actual use.

Discounted selling price

In some cases, where such large numbers of rapidly changing individual items are held, the only practical method of arriving at a figure to represent cost is to value the items at current selling price less the normal gross profit margin. For example, in the case of a department store, a valuation by reference to the ticketed selling price of the stock reduced by the appropriate departmental mark-up. This method of valuation is acceptable if it can be demonstrated that it gives a reasonable approximation of the actual cost. Whilst this method may lead to some undervaluation where the original ticketed selling price has already been reduced, other stock may never reach its ticketed selling price and to that extent would be overvalued.

This method may be described by accountants as the ‘retail method’.

Replacement cost method

Stock can only be valued at replacement cost in exceptional circumstances, such as:

  • Where the value of the raw material content forms a high proportion of the total value of stock in process of production and the price of the raw materials is liable to considerable fluctuation, it is common practice to make rapid changes in selling prices to accord with the changes in the price of the raw material. In cases of this kind the replacement cost basis may be extended to cover stock in process of production and finished stock as well as to the stocks of raw material.
  • In the case of traders such as motor and caravan dealers who acquire stock in part exchange transactions at a price that in substance includes a discount on the new vehicle sold. There is more detailed guidance on motor dealers stock at BIM52001.


Valuation should be at cost for any unused but useable consumables held at the balance sheet date. The circumstances would be rare and unusual to justify any valuation below cost. The trader would have to be in the position of knowing that the sale of the end product would result in a loss. Consumables are realised by being used and incorporated into or converted into the normal products the taxpayers sells. So unless they have deteriorated into unusability, are obsolete or otherwise unusable, they should only be valued at less than cost if the business expects to realise losses on selling their normal products.