B2.602 Trading stock—general principles

Trading stock

B2.602 Trading stock—general principles

Profits computed in accordance with generally accepted accounting practice form the starting point for the computation of taxable profits. Adjustments to those profits may need to be made to conform to tax law. It is important to understand how stock has an impact on the trading profits generated by a business.

Stock, often referred to as inventory, is an asset and its value at the end of the accounting period should be reported as a current asset on the balance sheet. However, the changes in stock are a component of the calculation of the cost of goods sold, which is considered to be an expense deductible from the sales figure in the profit and loss account. Some profit and loss accounts will show the calculation of cost of goods sold as opening stock plus net purchases less closing stock.

Having an accurate valuation of stock is important because the reported amount of stock will affect:

1.  

   •     the cost of goods sold, gross profit, and net income on the income statement, which will impact the taxable profits of a business

2.  

   •     the amount of current assets, working capital, total assets, and stockholders' or owner's equity reported on the balance sheet

In fact, incorrect accounting for stock will cause two profit and loss accounts o be incorrect. The reason is the opening stock of one accounting period will automatically become the closing stock in the subsequent