Trading stock rules for sole traders: opening and closing stock, the $5,000 rule and stock taken for home

What counts as trading stock

Trading stock includes items you hold for sale, raw materials and partly finished goods, and in some cases items you produce or farm, such as livestock. It does not include equipment you use to run the business, consumables you use up, or packaging you give away and do not sell. A hairdresser’s retail shampoo is trading stock. The salon chairs are not.

For a service business that sells almost nothing, there may be no meaningful stock at all. The rules matter when you hold a real range of products.

How the deduction works

The simple formula is opening stock, plus purchases, less closing stock, equals the cost of goods you deduct. If you start the year with $6,000 of stock, buy $24,000 during the year and finish with $9,000, your deduction for stock is $21,000. The $9,000 on hand at year end becomes the opening stock for next year.

In effect, a deduction for stock waits until the stock leaves your hands. A year of heavy buying before 30 June creates a higher closing balance and a smaller deduction, which is the opposite of a prepayment strategy. See prepaid expenses and the 12-month rule.

The $5,000 simplification

A small business entity can choose not to do a stocktake at year end if the difference between the value of its opening stock and a reasonable estimate of its closing stock is $5,000 or less. In that case, you just deduct your purchases for the year as you would any other expense.

If the difference is more than $5,000, you need a full count and valuation. The choice is made year by year, and you still have to keep records that justify your estimate. Confirm the current limit and conditions on the ATO site, since the test is applied to your own numbers.

How to value your stock

At year end you can value each item by one of three methods: cost, market selling value, or replacement cost. You can choose a different method for different items, but be consistent from year to year. Damaged or obsolete stock can be valued at a lower amount if you can show what it is realistically worth, for example the price you actually sold it for after the year end.

Cost means what you paid including freight in and non-refundable duties, less any discounts. Keep supplier invoices, because the cost is the figure the ATO will ask you to support.

Stock you take for your own use

If you take stock from the business for private use, including giving it to family, the ATO treats it as if you sold it at market value. That amount is added to your income. Some industries have published reasonable amounts for owner’s use, such as for food retailers, which you can use if you cannot track items exactly.

For GST, taking stock for private use is a taxable supply if you are registered, so you include one eleventh of the amount on your BAS. Samples and gifts of stock to customers are different, and you should check how to treat them. See client gifts and entertainment deductions.

GST and stock purchases

If you are registered, you claim the GST credit on stock when you buy it, with a valid tax invoice, not when you sell it. That means the credit comes early, and your BAS cash flow can look better in a heavy buying quarter. The GST on your sales goes the other way. See how to calculate GST.

Stock you buy second-hand has its own rules. See GST on second-hand goods.

Records to keep

Keep supplier invoices, the stocktake sheets or estimates you used at year end, notes on how you valued damaged items, and a record of stock taken for private use. Five years is the standard period. See record keeping requirements.

How FlowFi helps

FlowFi sorts stock purchases from other expenses and works out the GST on each, which gives you the purchases figure for the formula. It does not count your shelves, so the closing stock number is yours to supply or estimate.