Accounting for stock involves physical stock counts to its valuation at the financial year end. The closing stock value to be registered in your company accounts would have an impact on your corporation tax liability.
If your company is subject to an audit, your auditor will take a good look at your company’s stock valuation policy. Especially if the stock represents significant assets in the company’s accounts and high stock volume is involved.
Normally, your auditor would send their own people to attend stock take at your premises. They would use the stock record you provide them. They would test the effectiveness of your stock accounting system. they would seek understanding how your business is recording, valuing, managing and storing your stock items.
To begin with, they would select samples of stock items on your stock record and trace it through to the physical stock item. If they noted any variances in your physical stock to that of your stock record. They would want to know how you deal with damaged stock and missing stock and so on.
Consequently, your auditor would issue either a qualified or unqualified audit report. Ideally, you would like to have an unqualified audit report. Because this means your stock accounting system is good and gives a true and fair view of your company stock’s affairs.
However, if your auditor going to issue a qualified audit report, they would give reasons for their qualified report. You can then work to improve your stock accounting system so that you would not get the same audit report in the subsequent year. It is very important you get your stock accounting system right especially stock is your major asset in your business.
Objectives of stock valuation
The stock value included in your balance sheet represents your company’s current assets, it is often referred to as the stock or closing stock value. Usually, stock can be turned into cash fairly quickly if necessary. Concurrently, this closing stock value included in your balance sheet also represents the value excluded from your profit and loss account.
There are two objectives you can achieve playing with stock valuation figures. Firstly, you can shift your business profit from one year to another by overvaluing your stock to achieve minimum corporation tax liability. Secondly, you can create fictitious profit by undervaluing your stock.
For this reason, some companies may attempt to overvalue their stock in order to pay minimum corporation tax. On the other hand, others may try to undervalue their stock to improve their financial performance for borrowing or proposing dividends purposes. Dependent on what your business needs at the time. However, this is not allowed by law.
Stock accounting methods
Generally, there are three generally accepted methods of accounting stock.
- The First In First Out (FIFO)
- The Last In First Out (LIFO)
- The Weighted Average Cost valuation
FIFO is widely used by many businesses. The stock valuation using FIFO is stock that is received first is also sold first. LIFO is stock received last is sold first. This is opposite of FIFO. Whereas Weighted Average Cost valuation is taking all the stock costs and divide them by the number of stock to arrive at the average cost of stock per unit.
Generally speaking, choosing an accounting for stock method to use for your business is largely dependent on your business itself. For example, if you are in fresh fruits wholesale, the FIFO method may be suitable and if you are in a vintage wine seller then LIFO is.
Above all, your accounting for stock policy adopted must provide a true and fair value of actual physical stock held. In other words, your stock value shall be closest to its net realizable value or cost.
Stock items management
It is ideal to have a system to keep track of your physical stock. You may use a bespoke stock accounting system or manual stock recording system. Organised your physical stock storage for easy access and counting. This would ease your stock replenishment task too.
Occasionally, schedule a physical stock count. This would flag up the variances between your physical stock and stock on your system. You could then update your stock record accordingly.
Also, investigate the stock variances such as what made up the physical and system stock variances. Sometime, the stock could be still in transit or damaged or stolen. Encourage staff to report damaged stock items and have a record of how the stock was damaged.
On one hand, the regular stock count would also help to identify slow-moving stock items. What are you going to do with slow-moving stock items? You may sell it at a discounted price. Or maybe you return them to your suppliers if you have that arrangement in place.
Likewise, for high demand stock items, are the stock coming in on time to meet the demand?
Besides, regular stocktake would also encourage staff that handling stock to be more efficient in terms of storage and retrieving stock items.
Basically, the accurate physical stock would give you accurate stock value to be booked on your balance sheet. At the same time, it would also help you to make an informed decision on stock ordering and management.