Tax Book 2023

Method of Accounting and Records Chapter- 11

Example: From the following information provided by Zamir Ltd, compute the cost of stock in trade.

Opening stock (at fair value) Rs. 10,000, Purchases Rs.40,000 and Closing stock (cost) Rs. 5,000

Note: The NRV of closing stock is Rs. 4,000.

Solution:

Cost of stock in trade: Rs.

Opening stock 10,000

Add: purchases 40,000

Less: closing stock (at cost) (5,000)

Cost of stock in trade 45,000

Important note: The effect of NRV less than the cost has not been considered as it is abnormal loss

and the same will be charged to profit and loss account.

5. Computation of cost [u/s 35(5) and (6)]

Cash basis of accounting (Has two options for cost of stock in trade):

A person accounting for Income from Business on a cash basis may compute cost of stock on

either prime cost method or absorption cost method, and

Accrual basis of accounting (has only one method for cost of stock in trade:

a person accounting for business income on accrual basis shall compute the cost of stock on

absorption cost method.

For stock in trade not readily identifiable:

 Where particular items of stock in trade are not readily identifiable, a person may account

for stock on first in first out method or weighted average cost method

 Once chosen a stock valuation method may be changed with the written permission of the

CIR on such conditions as imposed by the CIR.

Definitions

 “Absorption-cost method” means the generally accepted accounting principle under

which the cost of an item of stock-in-trade is the sum of direct material costs, direct labour

costs, and factory overhead costs;

 “Average-cost method” means the generally accepted accounting principle under which

the valuation of stock-in-trade is based on a weighted average cost of units on hand;

 “Direct labour costs” means labour costs directly related to the manufacture or production

of stock-in-trade;

 “Direct material costs” means the cost of materials that become an integral part of the

stock-in-trade manufactured or produced, or which are consumed in the manufacturing or

production process;

 “Factory overhead costs” means the total costs of manufacturing or producing stock-in-

trade, other than direct labour and direct material costs;

 “First-in-first-out method” means the generally accepted accounting principle under

which the valuation of stock-in-trade is based on the assumption that stock is sold in the

order of its acquisition;

 “Prime-cost method” means the generally accepted accounting principle under which the

cost of stock-in-trade is the sum of direct material costs, direct labour costs, and variable

factory overhead costs;

 “Stock-in-trade” means anything produced, manufactured, purchased, or otherwise

acquired for manufacture, sale or exchange, and any materials or supplies to be consumed

in the production or manufacturing process, but does not include stocks or shares; and

 “Variable factory overhead costs” means those factory overhead costs which vary

directly with changes in volume of stock-in-trade manufactured or produced.