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Income Tax Act, 1962 (Act 58 of 1962)

Department of Finance

Practice Note No. 3

Valuation of Trading Stock with Special Reference to the Treatment of Overhead Excess and LIFO Reserves

 

 

Date: 2 September 1985

 

1) In terms of section 22(3)(a) of the Income Tax Act the cost price of trading stock shall include such "further costs" as contemplated in section 22(3)(b) of the Act.

 

2) Section 22(3)(d) provides for the determination and treatment of what is referred to as the "excess", (referred to in this practice note as the "overhead excess") while section 22(5)(d) and (e) provide for the creation and treatment of the LIFO reserve.

 

3) The following examples illustrate the operation of section 22 of the Act as it relates to the treatment of the "overhead excess" and the LIFO reserves. In all the examples the financial year ends on 31 December.

 

Example A

Situation:

Trading stock has always been valued on a first-in-first-out (FIFO) basis and the value of such trading stock did include "further costs" as envisaged in section 22(3)(a) and (b) of the Act.

Application:

As the "further costs" have been accounted for, the provisions of section 22(3)(c) and (d), which permit a phasing in of the "overhead excess" under certain conditions, do not apply.

 

Example B

Situation:

The trading stock has always been valued on a FIFO basis and has been determined on a basis where the "further costs" as contemplated in section 22(3)(a) and (b), have not been accounted for.

Assumptions:

Value of closing trading stock at 31 December 1984:

On a basis including "further costs"

R 300

(a)

On a cost price basis (i.e. excluding "further costs")

R 250

(b)

Application

"Overhead excess" to be phased in ((a) - (b))

R   50

Value of closing trading stock at 31 December 1984:

Value of stock including "further costs"

R 300

Less: Four-fifths of "overhead excess"

R   40

Tax value of stock on hand at 31 December 1984

R 260


 

Example C

Situation:

The value of trading stock on a LIFO basis has always included "further costs" as envisaged in section 22(3)(a) and (b).

Assumptions.

Value of opening trading stock at 1 January 1984:

On a LIFO basis:

including "further costs"

R   90

on a cost price basis (i.e. excluding "further costs")

R   80

On a FIFO basis:

including "further costs"

R 110

on a cost price basis (i.e. excluding "further costs")

R 100

Value of closing trading stock at 3 1 December 1984:

On a FIFO basis:

including "further costs"

R 125

on a cost price basis (i.e. excluding "further costs")

R 115

Application:

Value of trading stock at 1 January 1984:

On a LIFO basis including "further costs"

R   90

On a FIFO basis including "further costs"

R 110

LIFO reserve

R   20

Value of closing trading stock at 31 December 1984:

On a FIFO basis including "further costs"

R 125

Less: LIFO reserve

R   20

Tax value of trading stock on hand as at 3 1 December 1984

R 105

 

Since the "further costs" contemplated in section 22(3)(a) and (b) of the Act have been included in the past there is no "overhead excess" to be phased in.

 

Example D

Situation:

The value of trading stock on a LIFO basis has in the past been determined on a basis where the "further costs" have not been accounted for.

Assumptions:

As for example C.

Application:

Value of trading stock at 1 January 1984:

On a LIFO basis at cost price (i.e. excluding "further costs")


R   80

On a FIFO basis at cost price (i.e. excluding "further costs")


R 100

LIFO reserve

(A)

R   20

Value of trading stock at 31 December 1984:

On a FIFO basis including "further costs"


R 125

On a FIFO basis at cost price (i.e. excluding "further costs")


R 115

Overhead excess to be phased in

(B)

R   10

Value of closing trading stock at 31 December 1984:

On a FIFO basis including "further costs"



R125

Less:

LIFO reserve (A)

R 20



Four-fifths of "overhead excess" (B)

R   8

R 28

Tax value of trading stock on hand as at 3 1 December 1984



R 97