Chapter 3 - Trading stock valuation

• Consistency and disclosure requirement
• Agricultural produce

3.1 The trading stock valuation rules for taxation purposes are aligned with the accounting treatment in FRS-4 in a number of ways. Trading stock is valued at “lower of cost or market selling value” for taxation purposes under sections EB 6 and EB 11 of the Income Tax Act 2004, in accordance with FRS-4. Under section EB 7, cost is determined on the basis of the first-in first-out cost method or the weighted average cost method, which is consistent with the methods required under FRS-4. Furthermore, when the cost method is used for taxation purposes, the taxpayer must include and allocate costs under GAAP so that the value of the trading stock is not materially different from the value obtained by applying FRS-4.

3.2 Discounted selling price and replacement value (see sections EB 9 and EB 10) are the other two methods of valuation allowed under the trading stock rules if these methods are also used by the taxpayer for financial reporting purposes. When a taxpayer uses the market selling value for tax purposes, some expected costs of selling can be deducted from the market selling value provided that the taxpayer also did the same when calculating net realisable value for financial reporting purposes.

3.3 Under the new standards, NZ IAS 2 will replace FRS-4. The two are substantially the same with regards to the basic valuation methods, so the adoption of IFRS should not affect the ability of taxpayers to use the existing valuation methods under the current taxation rules. Potential problems with the valuation of agricultural produce are considered below.

3.4 We suggest that trading stock valuation rules continue to be aligned with the valuation methods adopted for accounting purposes, and that references to FRS-4 be amended to refer to NZ IAS 2.

Consistency and disclosure requirement

3.5 Sections EB 12 and EB 22 of the Act require trading stock to be valued consistently from one period to another and to all items of a similar nature for taxation purposes. Any change in trading stock valuation method should also be disclosed. This consistency and disclosure requirement is linked to the standards that normally apply for financial reporting purposes under FRS-1.[3]

3.6 With the adoption of IFRS, reporting entities must comply with the consistency requirements in NZ IAS 8 for financial reporting purposes. It requires an entity to apply its accounting policies consistently for similar transactions, other events and conditions. However, the entity can change its accounting policy if the change is required by a “Standard” or an “Interpretation” or results in the financial statements providing reliable and more relevant information. When changes have been made, the entity is required to disclose the impact and nature of these changes.

3.7 The consistency and disclosure requirements under NZ IAS 8 are substantially the same as those under FRS-1. We believe that these requirements should continue to apply to trading stock valuation for taxation purposes.[4] Legislative change will be required to replace references to NZ IAS 8 with references to FRS-1.

3.8 Low turnover traders who do not comply with GAAP have to meet a different consistency requirement defined in sections EB 22(2) to EB 22(4). The Act also specifies a consistency requirement for taxpayers who do not comply with GAAP, to ensure that they use a consistent cost-flow method to value their excepted financial arrangements. These requirements are not affected by the adoption of IFRS.

Agricultural produce

3.9 Under IFRS, taxpayers in the primary sector may be required to use the fair value method under NZ IAS 41, instead of NZ IAS 2, to value their harvested trading stock. Primary sector producers who are required to use the fair value method under NZ IAS 41 may be unable to comply with some of the existing requirements under the trading stock rules for taxation purposes.

Primary sector producers

3.10 For taxation purposes, the trading stock valuation rules may apply to harvested crops (that is, once the crops have been severed from land). Primary sector producers (who are not low turnover traders) can, in theory, use cost (sections EB 6 to EB 8), discounted selling price (section EB 9), replacement price (section EB 10) or market selling value (section EB 11) to value their trading stock. However, they may not be able to meet the legislative criteria in sections EB 6 to EB 11 in practice if they are required to adopt NZ IAS 41, since the standards require harvested crops to be valued at fair value for accounting purposes, while the tax rules assume that the accounting methods are primarily cost-based.

Primary sector producers who are low turnover traders

3.11 The problem is alleviated if the primary sector producers are low turnover traders. Low turnover traders have more flexibility in the methods they can use to value their trading stock for taxation purposes. In addition to the methods available in sections EB 6 to EB 11, they may, in theory, use any of the low turnover valuation methods prescribed in sections EB 15 to EB 21 or the special method for low value trading stock in section EB 23.

3.12 However, if low turnover traders have to comply with IFRS and use a fair value method to value their trading stock for accounting purposes, the valuation methods available under the taxation rules are cost under sections EB 16 and EB 17 or market value method in section EB 21.

3.13 We suggest that when primary sector taxpayers are using NZ IAS 41 for financial reporting purposes they be allowed to use sections EB 16 and EB 17 or EB 21 to value their harvested trading stock for taxation purposes.

3.14 The taxation treatment of livestock and unharvested crops should not change.

3 The same consistency and disclosure requirement applies to the use of cost-flow methods for excepted financial arrangements under section ED 1 for a person who complies with generally accepted accounting practice.

4 The same standard should also continue to apply to the use of cost-flow methods for excepted financial arrangements.