Valuing closing stock as a share trader?

[bellenuit]

When you value closing stock as a Share Trader, you are allowed the option of valuing your securities at Cost, at Market or the Lower of Cost or Market.

When using the Lower of Cost or Market, do you determine it on a security basis or can you determine it on a purchase lot basis within a security?

For instance, say my closing stock consists of 200 BHP bought in two lots of 100 each. To make things simple, lets ignore brokerage and tax. One lot (A) was bought at $20 per share and the other (B) at $30 per share and the closing price at the end of the tax year was $27.

So lot A's Cost price is $2,000 and Market Price is $2,700.
Lot B's Cost Price is $3,000 and Market Price is $2,700

Taken together, my 200 BHP has a cost price of $5,000 and Market Price of $5,400.

So if I want to value closing stock at the Lower of Cost or Market, do I use $5,000 (which is the lower of BHP taken as a whole), or can I use $4,700 which is the lower for lot A (= Cost) plus the lower for lot B (=Market)?

 

[bellenuit]

For those who may have the same question. I have contacted the ATO today and they have stated that you can in fact value your closing stock differently for each parcel of shares bought. So in my example, I would value Lot A at $2,000 and Lot B at $2,700.

Because of the method used to calculate trading profit, this should always yield the lowest reportable profit and hence reduce tax payable in the current year However, it will increase profit by a corresponding amount in the following years and you will be hit for the tax then.

 

[Wysiwyg]

However, it will increase profit by a corresponding amount in the following years and you will be hit for the tax then.

One of those little certainties in life hey.

 

[Krusty the Klown]

For those who may have the same question. I have contacted the ATO today and they have stated that you can in fact value your closing stock differently for each parcel of shares bought. So in my example, I would value Lot A at $2,000 and Lot B at $2,700.

Because of the method used to calculate trading profit, this should always yield the lowest reportable profit and hence reduce tax payable in the current year However, it will increase profit by a corresponding amount in the following years and you will be hit for the tax then.

I'd just like throw in a word of caution here Bellenuit.

Standard accounting practice is that all inventory items are valued using the one method for that tax year. So you use either market or historical cost method all purchases for that inventory item, but you do not mix the two in the one year. You can choose whichever method you like for all individual stock items.

This is for all stock holding businesses.

Did the ATO worker say that you could do it for different "parcels" of the same company?

It could also mean that the "parcels" were all different companies or inventory items.

Just curious cause it goes against standard practice that's all.

 

[cheeyeen]

For those who may have the same question. I have contacted the ATO today and they have stated that you can in fact value your closing stock differently for each parcel of shares bought. So in my example, I would value Lot A at $2,000 and Lot B at $2,700.

Because of the method used to calculate trading profit, this should always yield the lowest reportable profit and hence reduce tax payable in the current year However, it will increase profit by a corresponding amount in the following years and you will be hit for the tax then.

I was having the impression that you only pay tax on "realised profit"? So if you use the mark-to-market approach to value your closing stock, for tax purpose you will take out the "unrealised" profit or loss component in an adjustment or re-conciliation?

 

[skc]

I was having the impression that you only pay tax on "realised profit"? So if you use the mark-to-market approach to value your closing stock, for tax purpose you will take out the "unrealised" profit or loss component in an adjustment or re-conciliation?

You are allowed to do mark to market if you are a "trader" for tax purpose.

 

[bellenuit]

I'd just like throw in a word of caution here Bellenuit.

Standard accounting practice is that all inventory items are valued using the one method for that tax year. So you use either market or historical cost method all purchases for that inventory item, but you do not mix the two in the one year. You can choose whichever method you like for all individual stock items.

This is for all stock holding businesses.

Did the ATO worker say that you could do it for different "parcels" of the same company?

It could also mean that the "parcels" were all different companies or inventory items.

Yes, the ATO said that each individual parcel could be valued differently, even if the shares were for the same company.

The reason I posed the question here in the first place is that even though I use an accountant to prepare my company tax and financial reports, I usually do the latter myself as I have an accounting qualification, but have never actually practised. So to save costs, I do all the hack work myself and really just use my accountant to verify what I have done. This year was the first year that I valued stock items by the lower of cost or market and my accountant thought I was wrong to do it by parcel, but wasn't sure. It would be a few weeks before he could check. So I checked the Tax act and it states:

INCOME TAX ASSESSMENT ACT 1997 - SECT 70.45

Value of trading stock at end of income year
(1) You must elect to value each item of * trading stock on hand at the end of an income year at:
(a) its * cost; or
(b) its market selling value; or
(c) its replacement value.

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s70.45.html

However, nowhere in the act is defined what an "item of trading stock" is. When I phoned the ATO, after the initial responder stated that he wasn't sure what an "item of trading stock" was, he talked to an expert in his department who stated emphatically that, in relation to a share trader, an "item of trading stock" when it comes to valuing closing stock was the unsold portion of a share purchase transaction. I used the example I gave in this post and he confirmed that each parcel could be valued differently, even though the shares were for the same company. However, to be able to value at this level of granularity, you must be able to show that you have records at that level of detail. In my case, when I sell shares, I specifically nominate which parcel of shares or parcels of shares or part parcel of shares have been sold and record what quantities are remaining from those parcels. That way I am able to value what is left in each parcel at year end and what the cost price and market price is for the unsold portion of each parcel. Some traders, I believe, don't record that level of detail and just use an average cost for all shares for a particular company. Those traders obviously cannot then value at the more granular level.

As an aside, when I told my accountant of what the ATO said, he agreed that I was right. His initial response was based on assuming that you could not distinguish between different units of the same item once they had been purchased, as for example, 10 cm galvanised nails in a hardware store. But so long as you can track each purchase transaction right through to sale, there is no reason that (what is left of) the purchase parcel cannot be the "item of trading stock".

Regarding the comment: "Standard accounting practice is that all inventory items are valued using the one method for that tax year."

Yes you are correct. However, for a share trader an inventory item can be a parcel of shares bought in one transaction as described above. It needn't be all shares for a particular company.

 

[gooner]

From a corporate perspective, for financial markets products, tax is only paid on realised profits. Thus, market value adjustments for unrealised losses are not effective for tax purposes. Although, this will change with the Taxation of Financial Arrangements (TOFA) legislation that is effective from next year, or earlier if you make an election.

http://www.ato.gov.au/businesses/content.asp?doc=/Content/23954.htm

I do not trade enough to be on income account, however interesting to note that treatment is as trading stock for individuals. Is there an ATO reference on this? Personally I would have expected to see realised profits only taxed in line with the Corporate treatment.

 

[Wysiwyg]

INCOME TAX ASSESSMENT ACT 1997 - SECT 70.45

Value of trading stock at end of income year
(1) You must elect to value each item of * trading stock on hand at the end of an income year at:
(a) its * cost; or
(b) its market selling value; or
(c) its replacement value.

Just wondering how this is pertinent to shares in listed companies. I think shares in listed companies, valued at end of income year, can only be at "market selling value".

There seems to be a cross reference to 'stock' as in store or warehouse items which then involves considerations such as tax deduction claims for items of less market value than cost of purchase.

When shares are disposed then the cost base is the figure used to calculate taxable income or loss.

Can an example be presented where indisposed shares can have a tax deduction claimed? Or what is the advantage of alternative valuation methods? Please.

Here to learn, thank you.

 

[bellenuit]

Just wondering how this is pertinent to shares in listed companies. I think shares in listed companies, valued at end of income year, can only be at "market selling value".

There seems to be a cross reference to 'stock' as in store or warehouse items which then involves considerations such as tax deduction claims for items of less market value than cost of purchase.

When shares are disposed then the cost base is the figure used to calculate taxable income or loss.

Can an example be presented where indisposed shares can have a tax deduction claimed? Or what is the advantage of alternative valuation methods? Please.

Here to learn, thank you.

This only applies to share traders not investors. Investors pay capital gains tax on realised gains and costs are only deducted when the shares are sold (the costs become part of the cost base when calculating the capital gain or loss). Traders don't pay CGT but are taxed on their income from trading. Costs are deducted in the year they occur.

In relation to share trading, income from trading is Sales less Cost of Goods Sold. Cost of Goods Sold is Opening Stock plus Purchases less Closing Stock.

Sales are net proceeds (after deduction of transaction costs), Purchases are total cost to buy (after adding in transaction costs), opening stock is always set to previous years closing and closing stock can be valued by any of the methods discussed above.

Because of the flexibility of the latter, you can be taxed on unrealised gains.

As an example....

If you bought 100 BHP for $10 costing you $1000 and did nothing else that tax year and if at the end of the tax year BHP was worth $12.

If you value closing stock at Cost, then cost of goods sold is:

Opening Stock ($0) + Purchases ($1000) - Closing Stock ($1000) = $0.
Income is Sales ($0) - Cost of Sales ($0) = $0 so no tax.

If you value closing stock at Market, then Cost of Goods Sold is:

Opening Stock ($0) + Purchases ($1000) - Closing Stock ($1200) = -$200.
Income is Sales ($0) - Cost of Sales (-$200) = $200. $200 will be added to your other income and you will be taxed accordingly.

Note if BHP ended the year at $8, you would actually show a loss from trading of $200 (even though you didn't sell anything) and this would reduce your overall income.

The higher the cost of sales the lower the income by the above calculation. The lower the closing stock value is the higher the cost of sales is.

So by valuing your shares at the lower of Market or Cost, you are effectively minimising your income for this tax year and will pay less tax. However, it will all come out in the wash eventually so you really are just deferring tax.

This latter statement is not 100% true in that if everything is slowly going belly up, you are better off deferring tax to future years, as if things go so bad that you never make a profit you will not be paying tax in the future either. A bit too complex to give an example.

 

[Wysiwyg]

In relation to share trading, income from trading is Sales less Cost of Goods Sold. Cost of Goods Sold is Opening Stock plus Purchases less Closing Stock.

Sales are net proceeds (after deduction of transaction costs), Purchases are total cost to buy (after adding in transaction costs), opening stock is always set to previous years closing and closing stock can be valued by any of the methods discussed above.

Because of the flexibility of the latter, you can be taxed on unrealised gains.

Okay I understand that. I was under the impression that only on disposal of shares were the calculations made when in fact they are adjusted each income year until disposal.

Thank you.

 

[Krusty the Klown]

Yes, the ATO said that each individual parcel could be valued differently, even if the shares were for the same company.

The reason I posed the question here in the first place is that even though I use an accountant to prepare my company tax and financial reports, I usually do the latter myself as I have an accounting qualification, but have never actually practised. So to save costs, I do all the hack work myself and really just use my accountant to verify what I have done. This year was the first year that I valued stock items by the lower of cost or market and my accountant thought I was wrong to do it by parcel, but wasn't sure. It would be a few weeks before he could check. So I checked the Tax act and it states:

INCOME TAX ASSESSMENT ACT 1997 - SECT 70.45

Value of trading stock at end of income year
(1) You must elect to value each item of * trading stock on hand at the end of an income year at:
(a) its * cost; or
(b) its market selling value; or
(c) its replacement value.

http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s70.45.html

However, nowhere in the act is defined what an "item of trading stock" is. When I phoned the ATO, after the initial responder stated that he wasn't sure what an "item of trading stock" was, he talked to an expert in his department who stated emphatically that, in relation to a share trader, an "item of trading stock" when it comes to valuing closing stock was the unsold portion of a share purchase transaction. I used the example I gave in this post and he confirmed that each parcel could be valued differently, even though the shares were for the same company. However, to be able to value at this level of granularity, you must be able to show that you have records at that level of detail. In my case, when I sell shares, I specifically nominate which parcel of shares or parcels of shares or part parcel of shares have been sold and record what quantities are remaining from those parcels. That way I am able to value what is left in each parcel at year end and what the cost price and market price is for the unsold portion of each parcel. Some traders, I believe, don't record that level of detail and just use an average cost for all shares for a particular company. Those traders obviously cannot then value at the more granular level.

As an aside, when I told my accountant of what the ATO said, he agreed that I was right. His initial response was based on assuming that you could not distinguish between different units of the same item once they had been purchased, as for example, 10 cm galvanised nails in a hardware store. But so long as you can track each purchase transaction right through to sale, there is no reason that (what is left of) the purchase parcel cannot be the "item of trading stock".

Regarding the comment: "Standard accounting practice is that all inventory items are valued using the one method for that tax year."

Yes you are correct. However, for a share trader an inventory item can be a parcel of shares bought in one transaction as described above. It needn't be all shares for a particular company.

Well there you go, you learn something new everyday!!!

Could you imagine that detail of accounting for a business with a mass turnover of indistinguishable unit/inventory items? What a nightmare LOL!!

Thus I took the same line of approach as your accountant.

Thanks Bellenuit, that's very interesting!!

 

[bellenuit]

Okay I understand that. I was under the impression that only on disposal of shares were the calculations made when in fact they are adjusted each income year until disposal.

Thank you.

I do my trading under a company structure. It may be for different for individuals.