Trading stock is one of the few areas in Australian tax law where businesses have genuine flexibility in how they report. The choice of valuation method is made item by item, can be changed from year to year, and has a direct impact on taxable income. Understanding the rules — and using them appropriately — is a legitimate tax planning tool.
What is trading stock?
Trading stock includes anything held for sale or exchange in the ordinary course of business, and anything used in a manufacturing, professional, or similar process. Raw materials, work in progress, and finished goods all fall within the definition.
Items held as capital assets (equipment, vehicles) are not trading stock even if they might eventually be sold. The key is whether the item is held for sale in the ordinary course of business.
The opening stock / closing stock mechanism
The income tax treatment of trading stock works through an annual adjustment:
- If closing stock value exceeds opening stock value: the difference is assessable income
- If opening stock value exceeds closing stock value: the difference is a deduction
This means that increasing closing stock values increases taxable income (you are assessed on the increase in inventory value), and decreasing closing stock values reduces taxable income.
The three valuation methods
The ATO allows three valuation methods, which can be applied independently to each stock item:
1. Cost The historical cost of acquiring or producing the stock item. This includes purchase price, import duties, freight, and direct production costs. For manufactured goods, this includes a portion of factory overhead.
Cost is the most conservative method and generally gives the highest closing stock value (and therefore the highest taxable income in a period of stable or rising prices).
2. Market selling value The price at which the item could be sold in the current market. For stock that has declined in value since acquisition (obsolete lines, end-of-season products), using market selling value rather than cost reduces closing stock and therefore reduces taxable income.
This is the most commonly used alternative to cost for retail businesses with slow-moving or dated stock.
3. Replacement value The amount it would cost to acquire an identical item in the current market. For stock where the replacement cost has fallen (commodities that have dropped in price, for example), this gives a lower value than cost.
Selecting the lowest value
A business can select the lowest of the three values for each individual stock item. There is no requirement to use the same method across all stock lines. This allows a business to legitimately minimise its taxable income from trading stock by:
- Using cost for stock items where cost is lowest
- Using market selling value for items that have become obsolete or whose market price has dropped below cost
- Using replacement value for items where replacement cost has fallen below cost
The physical stocktake requirement
To support the closing stock value, a physical stocktake must be conducted at year end. The ATO does not require the stocktake to happen on exactly 30 June — businesses can conduct it within a few days before or after and adjust for movements — but the stocktake must be done.
For businesses that skip the physical count, the ATO can substitute a reasonable estimate of closing stock, which may not reflect the valuation method selections the business would have made.
Small business exemption
Businesses with aggregated turnover under $10M can elect to not account for changes in trading stock at year end if the difference between opening and closing stock is reasonably expected to be $5,000 or less. This saves the stocktake burden for very small inventory businesses.
GST and trading stock
GST is generally not included in the cost of trading stock for income tax purposes — it is claimed separately as an ITC. However, to the extent a business is not fully entitled to ITCs (partially exempt supplies, or the business is not GST-registered), the GST component becomes part of the cost.
Bookkeeping setup for trading stock
The accounts should separately track:
- Stock on hand (closing stock asset on the balance sheet)
- Purchases (for businesses using the periodic inventory method)
- Cost of goods sold (for businesses using perpetual inventory)
At year end, the difference between opening and closing stock is posted to trading stock adjustment in the P&L. This ensures the income tax return can correctly calculate the trading stock movement.
For businesses using point-of-sale systems (retail), the POS system typically tracks stock continuously. The year-end bookkeeping task is reconciling the POS closing stock value to the general ledger.