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HMRC internal manual

Business Income Manual

HM Revenue & Customs
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Stock: valuation: stock provisions

The calculation of a stock provision requires expertise and judgment, which the trader is normally in the best position to supply.

Since accountants dealing with unincorporated businesses will rarely have conducted an audit what follows generally only applies to those limited companies which have to produce audited accounts. An accountant carrying out an audit will normally have ensured that the client has:

  • applied appropriate procedures to identify defective, slow moving and obsolete stocks,
  • made reasonable and prudent estimates of the prices obtainable in the market in which the goods are expected to be sold at the time at which they will be available for sale, and
  • taken into account projected costs of completion and sale (for example, repair costs for damaged stocks and sales commission).

The accountant generally maintains a record of any formula used in the (permanent) audit file and should critically examine with the client its accuracy and relevance in the light of past experience and the conditions at the time of the audit (for instance it should reflect material changes in scrap values). Where the value of stocks is material it is normally regarded as important that the accountant carrying out the audit attends the stock taking. This gives the opportunity to look at slow moving, obsolete or defective stock and to verify the ‘cut-off’, that is, that items have been correctly included in stock where they were purchased before the reporting date or sold after it.

In a few cases calculating the provision can be relatively straightforward. For instance consider the position of a trader who has items that are either sold or thrown away and who has no further completion or sale costs. The trader applying his, or her, experience and expertise may decide that ten out of one hundred items will never be sold because of obsolescence and hence that a 10% provision is appropriate. That formula reflects not the reduction of the value of each item of stock but rather the complete writing off of the cost of those items that will never be sold. Whether it is acceptable depends on whether the assumption about obsolescence is justified.

Generally the precise calculation of an appropriate provision is more complex because other relevant factors need to be taken into account, for example, where there is physical deterioration, where there is normal wastage due to rejects, where the company offers stock on special clearance terms, where the scrap proceeds vary and where there are variable completion and sale costs. Rather than adopt a complex formula, traders often side-step the issues and adopt a simple formula of writing off an increasing percentage of the cost of stock held depending on its age at the reporting date.

The fact that stock is slow moving is not justification for a write-down below cost. It may be slow moving but still sell at a profit, for example antiques and jewellery.