BIM33140 - Stock: valuation: lower of cost and net realisable value: net realisable value

One of the acceptable basis of stock valuation is the lower of cost and net realisable value. The meaning of cost is discussed at BIM33135 and net realisable value is discussed below.

The realisable value is the expected sale price of the relevant stock in the condition in which it is expected to be sold in the traders normal selling market. From that value are deducted the estimated further costs which will have to be incurred to get the stock into its normal sale condition to arrive at the net realisable value. See also SSAP9, paragraph 21 of Part 2 and paragraphs 16-20 of Appendix 1.

Net realisable value may be less than cost because of deterioration, obsolescence, or changes in demand. At the accounting date, however, there may be a reasonable expectation that the proceeds of sale of some stock in future years will not produce enough income to cover its cost. If so, a loss on such stock should be recognised in the year under review by writing off the irrecoverable costs incurred.

If there is no reasonable expectation of sufficient future revenue to cover costs incurred then the stock should be stated at net realisable value. It is important to note that the valuation should be made on a normal commercial basis, for instance, it is not acceptable to value stock on the basis that it would have been sold in a forced sale on the balance sheet date in its then, possibly incomplete, state.

See BSC Footwear Ltd v Ridgway [1971] 47TC495 concerning the further costs that may be deducted in arriving at net realisable value (see Part 1 (5) and Part 2 (21) of SSAP9). Generally the further costs need to be directly related to the specific disposal of the goods in question (for example salesmen's commission, special promotional expenses etc) but precisely what costs can be directly related will depend on the particular facts.

Hindsight and SSAP17

Appendix 1 of paragraph 19 of SSAP9 provides that events occurring between the balance sheet date and the date of the completion of the financial statements need to be considered in arriving at the net realisable value and gives as an example a subsequent reduction in selling prices. SSAP17 is a detailed statement about the use of hindsight. The Appendix to SSAP17 includes ’the receipt of proceeds of sales after the balance sheet date or other evidence concerning the net realisable value of stocks' as an example of a post balance sheet event to be taken into account when completing financial statements. Inspectors should note that for the purposes of SSAP17 post balance sheet events are those events, both favourable and unfavourable to the trader, which occur between the balance sheet date and the date on which the financial statements are approved by the board of directors, or for unincorporated enterprises the corresponding date. However not all post balance sheet events should be taken into account in arriving at the figures in the financial statements, including the stock valuation. SSAP17 divides them into two categories ’adjusting events' and ’non-adjusting events':

• Adjusting events are events that provide additional evidence relating to conditions existing at the balance sheet date and they require changes to be included in the financial statements.
• Non-adjusting events concern conditions that did not exist at the balance sheet date and they do not result in changes in the financial statements, but they may be significant enough to justify a note to the accounts.

Example: A farming company had one of its crops destroyed, after the balance sheet date but before the accounts were completed, by a disease which was present, albeit undetected, in that crop at the balance sheet date. In the financial statements being prepared it would be entitled to write that stock down to its nil net realisable value as that would be an adjusting event. On the other hand the destruction of a crop by fire, after the end of the accounting period but before the accounts were completed would be a non-adjusting event. It would not justify writing down that stock to a nil net realisable value in the financial statements being prepared.

The application of SSAP17 has not been tested by the courts but the remarks of Warner, J on pages 660, 670, and 680 in Symons v Lord Llewelyn Davies [1982] 56TC630, suggest that they would accept its correct application.

Moreover, where they are available, facts are preferable to speculative estimates, (the Bwllfa principle). For tax purposes it is not acceptable to ignore facts if by doing so an unreal loss is anticipated.