CONTEMPORARAY TAXATION; ACC: 300

Lectures – Stock in Trade

Power of Board to Prescribe Method, etc

In the case of any business the Federal Board of Revenue (FBR) is empowered
prescribe the manner in which firm has to maintain accounts and record payments of
business transactions (i.e. on accrual basis or on cash basis)

Change in Method of Accounting:

For the change in method of accounting special permission of concerned Commissioner

is required.

Cash-Basis Accounting

According to the Income Tax Ordinance, 2001 Cash-Basis Accounting means such
method in which income and expenditures are accounted for when cash is actually
received or paid.

Accrual-Basis Accounting

According to the Income Tax Ordinance, 2001 Accrual-Basis Accounting means such
method in which income and expenditures are accounted for when they derived or
incurred. OR

Income and expenditures are accounted for when they become receivable or payable.

Example-1

A company received a bill for an expense of Rs. 300,000 as at 30 th June, 2015.

Expense was incurred during the month of June, 2015. The bill was paid at 10 th July,
2015. When the expense should be accounted for according to both methods

Solution:

Method Date of recording of expense

Cash basis 10th July, 2015

Accrual basis 30th June, 2015

COST OF STOCK-IN-TRADE

Stock-in-Trade

It means anything manufactured, purchased or otherwise acquired for sale or exchange

or to be consumed in manufacturing.

Written by: Ms Hafiza Noshaba Nisar

 CONTEMPORARAY TAXATION; ACC: 300

Value of Opening Stock-in-Trade

According to the Section 35 of the Income Tax Ordinance, 2001 value of opening stock
is determined differently in following two situations:

1. If Business was commenced before the start of the Tax Year under
consideration:

If Business was commenced before the start of the Tax Year for which the
opening stock is to be valued, the Value of Closing Stock of the previous year will
be considered as the value of Opening Stock of the current year under
consideration; e.g. the value of closing stock as at 30-06-2018 was 200,000. The
value of opening stock for the Tax Year 2019; i.e. as at 01-07-2018 will be
considered as the same as it was at the closing of Tax Year 2018; i.e. Rs.
200,000.

2. BUT if Business was commenced after the start of the Tax Year under
consideration:

If business was commenced after the start of the Tax Year and an stock was
purchased before that commencement and the company wants to used the same
for business purpose, such stock will be considered as opening stock of the
business and valued at Fair Market Value of the Stock at the date at which the
stock will be used / introduced for the business purpose.

Methods of calculating Cost of closing stock-in-trade

To calculate cost of stock-in-trade following methods are applicable based on

accounting methods:

1. Prime cost method

2. Absorption cost method
3. First-in-first-out (FIFO) method
4. Average cost method

Absorption Cost Method

It is a generally accepted accounting principle under which:

Cost of an item of Stock-in-trade = Direct Material costs + Direct Labor Costs + Factory
Overheads

Direct Material Costs

It means cost of materials which are consumed in the manufacturing of stock-in-trade

Written by: Ms Hafiza Noshaba Nisar

 CONTEMPORARAY TAXATION; ACC: 300

Direct Labor Costs

It means labor costs directly related to manufacturing of stock-in-trade

Factory Overhead Costs

It means the total cost of manufacturing stock-in-trade less direct labor costs and direct
material costs; i.e.

Factory Overhead Costs = Total manufacturing cost – Direct Material cost – Direct
Labor cost

First-in-First-Out Method

It is a generally accepted accounting principle under which stock will be sold in

sequence of its acquisition; i.e.

Items which are acquired first will be sold first and items which are acquired later will be
sold later.

Average Cost Method

It is a generally accepted accounting principle under which:

Value of units of Stock-in-trade = Weighted Average cost of units in hand

Example-2

Company purchased a stock contains 100 units of Rs. 20 each then 50 units of Rs. 25
each and then 15 units of Rs. 22 each. Now company has closing stock of 30 units.
Calculate the cost of stock by using weighted average and FIFO methods.

Solution:

Average Cost Method

Per unit Cost of Stock = Weighted Average of all units

= (100x20+50x25+15x22) / (100+50+15)
= 2000+1250+330 / 165
= 3580 / 165
= 21.697 per unit
Cost of closing Stock = 30*21.697
= Rs. 650.91

FIFO Method

Written by: Ms Hafiza Noshaba Nisar

 CONTEMPORARAY TAXATION; ACC: 300

As the company purchased total 165 units with the sequence of 100 then 50 then last
15 units. Now the company has closing stock of total 30 units according to FIFO method
these 30 units should be from last purchase15 units of Rs. 22 each and from 2 nd last
purchase of 50 units of Rs. 25 each. Therefore the value of stock

Cost of Stock = 15x22 + 15x25 = 330 + 375 = 705

Value of Closing Stock-in-Trade

Closing value of stock is lower of the cost or net realizable value of the stock-in-trade on
hand at the end of the year.

Net realizable value = Selling price – (cost of completion + selling expenses)

Example-1

Cost of closing stock is Rs. 150,000. Selling price is Rs. 350,000, labor and other cost
of completion is Rs. 100,000, Selling expenses are Rs. 50,000. You have to calculate
value of closing stock-in-trade.

Solution:

As the cost of Rs. 150,000 is less than NRV of Rs. 200,000 (W-1) therefore cost of
closing stock-in-trade will be taken as its value.

(W-1)

As NRV = Selling price – cost of completion – selling expenses

= 350,000 – 100,000 – 50,000
= 200,000

Explanation

Equation-1:

Selling price = Profit + Cost

OR
Selling price = Profit + Cost of Material + Labor + Overheads + Selling Expenses

OR
Selling price = Profit + Cost of Material in hand + Cost of Material further required till
completion + Labor required for completion + Overheads required for completion +
Selling expenses

As (Cost of Material required for completion + Labor + Overheads) = Cost of completion

Written by: Ms Hafiza Noshaba Nisar

 CONTEMPORARAY TAXATION; ACC: 300

Therefore equation 1 can be written as

Selling price = Profit + Cost of Material in hand + Cost of completion + Selling expenses

OR
Selling price – Cost of completion – Selling expenses = Profit + Cost of Material in Hand

As NRV = Selling price – Cost of completion – Selling expenses

Therefore Equation 1 can be written as

NRV = Profit + Cost of Material in hand

If cost will be lower than NRV than it will be taken as value of closing stock if NRV will
be lower than cost it means the product is in loss in that case NRV will be taken as
value of closing stock.

Value of Stock-in-Trade Consumed during the year

The value of stock-in-trade disposed off during a tax year shall be determined as below:

A+B-C = D

Where:

A: Opening value of stock in trade

B: Cost of the stocks acquired (total material purchased) during the year
C: Closing value of stock in trade
D: Cost of stock-in-trade consumed during the year

Written by: Ms Hafiza Noshaba Nisar