Question:
Discuss about the Accounting for Inventory & Trade Stock for Tax Purposes.
Income Tax Assessment Act requires that all entities in operation making profits or loss to declare their respective tax return obligation at the end of each financial year as referred cited by Kirchler(2010.Pg 340).The act further emphasizes the need to include all gross earning and sale proceeds revenue generated for tax purpose in the books as assessable income. Accounting for inventory is so vital that no firm can’t ignore its’ accountability simply because is an item that rotates across cash i.e. from purchases to sales thus a great contributor to value addition tax.
Tony is seen from the information available to be conducting the business of selling both new and repaired gazebos chairs. From this, of course, the conclusion can be, made that Tony gets revenue from sales of six chairs each at $500 thus generating $3000 as well as from sales of four repaired gazebos that earned him $78 revenue. However, the revenues are subjected to deductible allowable cost and expenses as illustrated below;
Cost of manufacturing the chairs sold =$250*6=$1500
Repaired Chairs cost =$20
Replacing Cost i.e. the 8 Chairs=$15*8 =$120
All these costs relate to the above revenue of $3078 thus can use them to arrive at the net profit before tax of=$3078-$1500-$20-$120=$1438, this profit is what that worth to be subjected to tax. If we were to subject the revenue to tax without netting off the cost, of course, the tax obligation would be high however the ATO proclaims irrational sense in accounting for revenue without expenses or costs. Tony’s costs of gazebos relating to inventory balances worth to be classified as deductible allowable for tax purposes.
Inventory balances should be considered for tax purposes as per the set regulation in Sec 28 of Income Tax Assessment Act. This is to be conducted through physical stocktaking which defines the balances as at the start and end of the financial year. Any change in stocks whether under, over or at constant state has different implication on the taxable income.
We most all agree that in a manufacturing or business set up that involves usage of raw material at respective stages, of course, we can’t miss the aspect of the cost of sales. In Tony’s Sale of gazebos business there exist cost of sales items whose accountability has been achieved through;
Opening Stock + Purchases – Closing Stock=Consumption
Opening and Closing stocks are attained through stock taking and each one of them has an impact on the taxable income individually for example; 2015/2016 Tony did not have opening balances in real sense the stocks worth $25 is what he acquired and what was seen to be the closing balance thus dictating that Tony did not have any cost of sales items in that end of 2016 since the effect on cost of sales=$0+$25-$25=0, this is therefore seen to contribute to increasing the taxable income since there are no deductions resulting from it Cernius(2016.Pg17).
Trade inventory balances are seen to determine Tony’s sales position. This is so through changes happening in the balances i.e. a firm commencing its operation as at the end of the year the only exception for stock differences to be summed in the assessable income. The decrease in stocks especially closing balances greatly contribute to allowable deductible balances whereas an increase shoots up the tax assessable income as referred by Cernuous (2016.Pg 67).
According to Australian Taxation Law Office trading stocks is defined to be whatever firms produces, makes, manufactures or acquires for the sole consumption purposes in manufacturing, selling and in exchange processes. It is prudent to know that for an inventory to qualify to be a trading stock the test of finding out whether the latter item facilitates operational processes in yielding economic reward benefit Knur(2014.Pg38).
The act requires an entity to account for trading stocks through stocktaking so as to determine closing stock balances at hand as at start and close of the year. It is deemed that a trader taxable income is ascertained through stock valuation more so while accounting for cost of sales items
Tony’s income going with the set roles on stocks balances is seen to be changing the assessable income upwards during period 2015/2016 whereas 2016/2017 the opening balance is seen to be less than the closing balance as it is seen to shoot up the value to $35.
Yr 2016 COS 5 second hand gazebos=0+$25-$25=0
Yr 2017 COS=$25(Opening Stock+$30(Purchases)-$35(Closing Stock) =$20
$35(Closing Stock Valuation) =1 chair from the 5 bought 2nd hand=1*=
It is from the above synopsis that Tony’s gazebo for new and repaired chairs is seen to account for trading stocks Guo(2012.Pg87). The gazebos are seen to generate economic rewards hence worth to be classified as trading stocks.
Obsolescence means not in use or outdated thus creating as the aspect of loss Cannella(2015.Pg124) that has to be accounted for in the books. Tony’s nominal value of $1 undervalues or understates stock value thus creating stock or inventory loss. By virtue of record keeping the stock, the loss is assigned to counter income thus treated as allowable deductions for tax purposes. An obsolete stock is further seen to reduce the balances of stocks hence subjecting the latter for tax purposes Kök(2014.Pg100).
Upon analyzing Tony’s business we are dutiful to conclude that he deals with trade stocks acquired externally while some he locally adds value to it. The stocks are either acquired or sold via purchases or sales Date (2005.Pg17). The law thus advises accountability of goods sales and purchase through payment of input and output tax aspects.Tony is therefore advised to register for Goods Sales Tax purpose so as to counter the GST input tax McCarthy(2011.Pg61) from purchases and sales output tax Evans(2011.Pg140). Use of Good Sales Tax will control and create efficiency in Tony’s operation as well as facilitating tax burden planning. Tony need to register for GST so as to be claiming taxes he paid while purchasing the gazebos this should be used to set off output tax. Although this GST on purchases is claimable upon registration and upon purchase there exist instances where you pay for inventory you already had at hand before registration.
Inventory at hand is mostly as result of purchase made thus as at the time of making the purchase GST was charge on this purchase thus always leaving the seller and buy with the task of accounting for this charge for tax purposes. Input tax results from purchases made while output result from sales made the two as per GST regulations should contra each other and thus allowing for tax refund or tax payable.
Although anything held for the sole need of facilitating smooth operations in a firm is what is classified as trade stock. The main course of business for this taxpayer is servicing and selling computers, therefore, anything that contributes to this course whether tangible or intangible should be treated as trade stocks. Servicing of these computers can’t be complete in absence of the spare parts thus classifying the spare parts as trade stocks.
These spare parts since they are used to facilitate operations with economic reward expectation it qualifies to be a trading stock Wong(2007.Pg 380). Likewise, since they stand on its own individual traits without any alteration for identifiable purposes they qualify to be trade stock.
Since the spare parts are disposable in nature upon transfer to customers after servicing it qualifies it to be trade stock.
Despite the fact that the computers are leased, the taxpayer is still seen to use the spare parts to service the items that had already generated reward, from this, therefore, the conclusion is that the spare parts are classified as trade stocks.This is so because they are used to render maintenance service. However, the classification is only applicable if the spare parts period is that of less than a year or a year of which in our case an assumption of it being used for one year is applied.
Spare parts are therefore classified depending on the time aspect whereby if it’s used to operate an asset for duration less than a year then it worth classified as trade stock and vice versa. Likewise, the classification is made on the purpose or sole use of the spare part whereby if it’s used for rendering any service like in our case maintenance or for production purpose.
References
Bainbridge, K.E. and Wallhagen, M.I., 2014. Hearing loss in an aging American population: extent, impact, and management. Annual review of public health, 35, pp.139-152.
Cannella, S., Framinan, J.M., Bruccoleri, M., Barbosa-Póvoa, A.P. and Relvas, S., 2015. The effect of inventory record inaccuracy in information exchange supply chains. European Journal of Operational Research, 243(1), pp.120-129.
Cernius, G., Birskyte, L. and Balkevicius, A., 2016. Influence of Rules for Computing Corporate Income Tax on the Accuracy of Financial Statements of Lithuanian Companies. Scientific Annals of Economics and Business, 63(1), pp.65-81.
Dyte, R., 2005, June. What is the use of financial compliance? The case of small business in Australia. In INTERNATIONAL COUNCIL FOR SMALL BUSINESS (ICSB) WORLD CONFERENCE (Vol. 50, pp. 15-18).
Evans, M., Peacock, and C., 2011. The GST Treatment of Financial Services in Australia. GST in Australia: Looking Forward from the First Decade, pp.133-160.
Guo, Y., 2012. Research on Choices of Enterprise Inventory Valuation Methods and Taxing Planning. Friends of Accounting, the First Half of the Second Issue, pp.86-88.
Kirchler, E. and Wahl, I., 2010. Tax compliance inventory TAX-I: Designing an inventory for surveys of tax compliance. Journal of Economic Psychology, 31(3), pp.331-346.
Kök, A.G. and Shang, K.H., 2014. Evaluation of cycle-count policies for supply chains with inventory inaccuracy and implications on RFID investments. European Journal of Operational Research, 237(1), pp.91-105.
Konur, D. and Schaefer, B., 2014. Integrated inventory control and transportation decisions under carbon emissions regulations: LTL vs. TL carriers. Transportation Research Part E: Logistics and Transportation Review, 68, pp.14-38.
McCarthy, D., Peacock, and C., 2011. The Australian GST–Why It Is the Way It Is and Where To from Here?. GST in Australia: Looking Forward from the First Decade (Thomson Reuters, Sydney, 2011), 61.
Schmidlin, N., 2014. The Art of Company Valuation and Financial Statement Analysis: A value investor’s guide with real-life case studies. John Wiley & Sons.
Wong, H., Van Oudheusden, D. and Cattrysse, D., 2007. Cost allocation in spare parts inventory pooling. Transportation Research Part E: Logistics and Transportation Review, 43(4), pp.370-386.
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