Stock held at the year end is valued at the lower of its cost and its net realisable value, which FRS 102 calls estimated selling price less costs to complete and sell. The comparison is made item by item, or for groups of similar items, never on the total. HMRC accepts this basis for tax, but not LIFO, base stock or replacement cost, and it applies market value rules when stock is taken for own use or transferred on a cessation.

What does lower of cost and net realisable value mean?

Paragraph 13.4 of FRS 102 requires an entity to measure inventories at the lower of cost and estimated selling price less costs to complete and sell. The same rule appears in company law: for small companies, Schedule 1 paragraph 23 of SI 2008/409 says a current asset is included at its purchase price or production cost, and paragraph 24 says that if net realisable value is lower, net realisable value must be used instead.

The logic is prudence. Stock is carried forward at cost so that profit is recognised when it is sold, but if the business expects to sell it for less than it cost, the loss is recognised now rather than when the sale happens. If the reason for a write down later disappears, paragraph 24(2) of the same schedule and FRS 102 paragraph 27.4 require the write down to be reversed, but never above original cost.

What counts as cost?

FRS 102 paragraph 13.5 says cost includes all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. In more detail:

  • Costs of purchase (13.6): purchase price, import duties, taxes that are not recoverable, and transport, handling and other directly attributable costs, less trade discounts and rebates. VAT that the business can reclaim is not part of cost.
  • Costs of conversion (13.8 and 13.9): direct labour plus a systematic allocation of fixed and variable production overheads. Fixed overheads are allocated on the basis of normal capacity, so idle time or low production does not inflate the cost of each unit.
  • Excluded costs (13.13): abnormal waste, storage costs (unless needed in the production process), administrative overheads that do not bring stock to its present location and condition, and selling costs. Company law makes the same point at Schedule 1 paragraph 27(4): distribution costs may not be included in the production cost of current assets.
  • Service providers (13.14): work in progress is measured at the cost of the staff directly engaged in providing the service and attributable overheads, without any profit margin.

Which cost formulas are allowed?

Where items are not ordinarily interchangeable, such as bespoke goods or specific projects, paragraph 13.17 requires specific identification of their individual costs. For everything else, paragraph 13.18 requires either first in, first out (FIFO) or weighted average cost, applied consistently to stock of a similar nature and use, and states that last in, first out (LIFO) is not permitted. Paragraph 13.16 allows standard costing, the retail method or most recent purchase price as measurement techniques if the result approximates cost.

Company law is wider. Schedule 1 paragraph 28 of SI 2008/409 lists FIFO, LIFO, weighted average and any other method reflecting generally accepted best practice. A company preparing FRS 102 accounts is still bound by paragraph 13.18, and for tax HMRC’s guidance at BIM33125 lists LIFO, base stock and notional replacement cost as bases that are not acceptable. BIM33120 traces the rejection of LIFO to the Privy Council decision in Minister of National Revenue v Anaconda American Brass Ltd [1956].

How is net realisable value tested?

FRS 102 paragraph 27.2 requires the comparison to be made for each item of stock, or for groups of similar items. Paragraph 27.3 allows grouping only where it is impracticable to work item by item, and then only for items in the same product line with similar purposes or end uses, produced and marketed in the same geographical area.

HMRC’s guidance at BIM33140 explains that net realisable value may fall below cost because of deterioration, obsolescence or changes in demand. It is based on a normal commercial sale, not a forced sale, and the further costs deducted should be directly related to selling the goods in question, such as sales commission. A fall in selling prices after the year end is an adjusting event under FRS 102 Section 32, so it is taken into account. BIM33145 adds that slow moving stock is not automatically worth less than cost, and that formula based provisions are acceptable if each formula reflects a realistic appraisal.

What does a worked example look like?

Illustration only. A retailer counts three product lines at its year end.

Line Cost Selling price less costs to sell Value used
A: current range £2,000 £3,500 £2,000
B: discontinued range £1,500 £1,100 (£1,200 less £100 commission) £1,100
C: seasonal stock £800 £1,000 £800
Total £4,300 £5,600 £3,900

Closing stock is £3,900, a write down of £400 on line B. Comparing the totals instead (£4,300 against £5,600) would wrongly show no write down at all, because the profit expected on lines A and C would hide the loss on line B. The write down increases cost of sales and reduces profit in this year, and it is deductible for tax because it follows a basis HMRC accepts.

How does HMRC treat stock values for tax?

BIM33115 says there are two acceptable bases for stock and work in progress: lower of cost and net realisable value, and mark to market. All other bases are not acceptable. Accounts prepared under generally accepted accounting practice are generally accepted if the method is applied correctly and reflects the facts, and HMRC cannot substitute one valid basis for another.

Two statutory rules override the accounts. First, stock taken out of the business for private use, or otherwise disposed of outside the course of the trade, is treated as sold at market value under sections 172A to 172F ITTOIA 2005 and sections 156 to 161 CTA 2009, which put the Sharkey v Wernher principle on a statutory footing (BIM33630). Recording drawings of stock at cost understates profit. Second, special rules apply when the trade ends.

What happens to stock when a business stops trading?

On a cessation, BIM33470 explains that stock is generally valued at what would be given in an arm’s length sale. If it is sold to an unconnected UK trader who will deduct it in their own trade, the price actually paid is used. If the buyer is connected, the arm’s length value is substituted under section 177 ITTOIA 2005 or section 166 CTA 2009. The two parties can jointly elect, under section 178 ITTOIA 2005 or section 167 CTA 2009, to use the greater of the price paid and the acquisition value instead, provided the arm’s length value is more than both. The election must be made within two years after the end of the chargeable period in which the trade is discontinued (BIM33480). This often comes up when a sole trader incorporates or a company is wound up; see closing a limited company and connected persons.

What mistakes come up most often?

  • No proper stock count. Section 386(4) of the Companies Act 2006 requires a company dealing in goods to keep statements of stock held at the year end and the stocktaking records they were prepared from.
  • Including selling or storage costs in cost. Both are excluded by FRS 102 paragraph 13.13.
  • Blanket percentage provisions. A provision needs a realistic basis line by line or for groups of similar items.
  • Testing on totals. As the example shows, this hides losses.
  • Ignoring own use. Goods taken for personal use go through at market value.
  • Changing formula without disclosure. FRS 102 paragraph 13.22 requires the accounting policy, including the cost formula, to be disclosed, and BIM33199 deals with changes of basis.

Stock adjustments are posted as part of the year end journals alongside accruals and prepayments, before the final trial balance is extracted. Businesses on the cash basis follow different rules; see cash basis vs accruals accounting.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.