As a crafting business you often are both manufacturer and retailer. Stock control is important so you know what you’ve got on hand to sell, but it also matters for working out your expenses for tax. You need to know what you started with, what you used, what you’ve sold and what you’ve got left.
To be absolutely clear, you can only claim the underlying expenses relating to the products you have actually sold (or have left your ownership) in the Trading Period – all the other expenses for raw materials/ supplies etc that you’ve bought aren’t eligible for tax relief until those materials or supplies have been sold. They just sit in your stockpile until they are ‘used up’.
So, if you have been claiming expenses for raw materials or supplies purchased during the Trading Period that you haven’t actually used to make something that has actually been sold or otherwise taken out of your ownership during the Trading Period– technically you’ve been doing it wrong because that’s the ‘cash basis’ and you should be using the Accruals Basis (see the last post about Cash & Accruals Basis). To regularise your position you will have to make an adjustment to add back the expenses you have overclaimed in earlier years, based on what stock you have on hand on the first day of your new Trading Period. You really also ought to tell HMRC, which could lead to a revised and higher tax liability for earlier years (or reduced losses), penalties and penalty interest.
Featured Seller: Poppy Sparkles (Viv Smith) See her Etsy shop here
and about her work at the foot of this article
What is Stock and what can I claim?
At any given point in time you probably possess
- raw materials or consumables (that you bought or someone gave you for free), and
- products that you are half-way through making or work in progress, and
- products that you’ve finished making that are ready to sell or finished goods, and
- goods for resale (for example destashing), and
- if you do custom orders, money on account from buyers.
To get to the stock level at your year end on the strict basis, you need to do the following calculation:
- Stock you’ve added during the year that you paid for (less any adjustment if you’ve overclaimed expenses in earlier years as above. The adjustment reduces the stock added figure).
- PLUS opening stock at the beginning (zero for new businesses, or last year’s closing Stock figure for continuing businesses)
- LESS what’s left in Stock at the end of the year (this year’s closing Stock figure)
- EQUALS what Stock you’ve used during the year. This is the figure that HMRC are interested in for your tax return. If after your adjustment for overclaiming expenses in earlier years (as above), this figure is a minus, you really need to discuss it with HMRC before you file your return as it should be a positive figure.
If you don’t have large volumes of raw materials or finished products building up, and you make sure you don’t have any unfinished products at your year end, it’s not difficult to keep track of the value of what raw materials have been turned into finished products and been sold or the value of what finished goods offered for resale have been sold – which is effectively what HMRC are interested in for your tax return. But if you have slow stock turnover or high stock levels, it really is a good idea to follow the strict basis calculation so you don’t miss anything out or doublecount it. Also, sometimes you have to include values for stock that don’t actually represent real cash (see below).
Let’s pretend you are doing the full calculation because then you’ll know what actually goes into the figure the HMRC are interested in for what they call ‘cost of goods bought for resale or goods used’ for the Full Self-Employment pages, but which also forms part of that single Total Expenses figure you need for the Short Self-Employment pages of your tax return.
Stock added this period – Raw Materials - purchased, gifted or bartered?
Most of the stock you’ve added to your business will have cost you money – if it was at normal market value (not a special price just for you) you use the price you actually paid.
But some stock might have been given to you for free or at a significant discount or as a swap. If you received stock for free, your price for that stock is ZERO (forever).
If it was at a very significant discount, then if HMRC asked questions they might recalculate your figures and substitute the discounted price with the price that anybody else would have to have paid (normal market value), but otherwise, you use the price you paid for it.
If you obtained the stock through a swap or barter transaction, then you have to use a value that relates to the monetary value you and the person you bartered with have put on the transaction – pretty much what it would have cost if you’d done the transaction with money instead of swapping.
So, if you bought, and bartered some stock during the year, your stock calculation contains some numbers that are real cash (reflected in your bank account or pockets) and some numbers that aren’t real cash, but which still need to be counted to work out your taxable profits – which I’ll call ‘ghost’ numbers for want of a better word. It’s important you understand this, because if your eventual stock figure on your tax return doesn’t reconcile back to your cash position, it’s because of these ‘ghost’ numbers.
Stock added this period – Work in Progress – Unfinished items
This only applies to products that you’ve started working on but haven’t actually finished on the day your year ends. It’s part of the Accruals Basis (see the last post).
For unfinished items - you have to work out two sums and then you take the lower value as the value of the unfinished stock:
- What is the cost of the unfinished item(s) to date? You do NOT include the cost of your time to get as far as you have in this, just the materials; because you’re a sole trader, but if you have a helper or employee, you do include the cost of their time.
- What is the price you would sell it for if it was finished, LESS an estimate of the further costs required to get the unfinished item to the finished state. Again, you’re a sole trader, you don’t include your time, but you do include a helper or employee’s time.
In an ideal world, you make sure you don’t actually have any unfinished custom orders or unfinished product items hanging around at your year end, then you don’t have to do this calculation at all!
End of year stocktaking
Following the strict calculation, you work out what stock you have left each year by doing an annual Valuation or Stocktake. Basically this means looking at your list of opening stock, and stock added, and comparing that to what you’ve still got at year end. You are checking whether its value has stayed the same or reduced (maybe because of damage or deterioration or its passed its sellby date or it was stolen). If the value has reduced, then you reflect that change when you add up the value of all the stock you have left. If the stock came in at zero (say as a gift) it stays at zero in the annual stocktake.
The figure for your annual stocktake is your closing stock figure for the current Trading Period, and also your opening stock figure for the next Trading Period. If you need to make any adjustments, say because you’ve decided that you want to do it properly on the strict basis going forwards, then you put in the correcting figure as though you incurred the cost on the first day of the new Trading Period. You never add the adjustment to the closing figure to get a new opening figure.
Result: Stock used during the year
If you take your opening stock, add new stock and take away the end of year stocktaking value, you end up with a figure which equals stock used during the year.
What that final figure represents is:
- The cost of materials (stock) used in items you sold in the year
- The value by which materials (stock) went down because of damage or deterioration
- The value you can claim as an allowable expense in your tax return.
If you still own the stock until it’s sold, then it needs to be included in your annual stocktake as still being part of your Stock (probably reduced in price due to sticky fingers & careless handling).
However, if your agreement with the shop or gallery says that they own the stock in their shop, then it counts as stock used, as though it was sold. You record the price that shop owes you as income according to the date the contract or your invoice says the income was due, even if the stock leaves your ownership before the end of the tax year, and the income’s due date is afterwards – you end up with a timing difference and a bit of a mismatch between expense & income.
If you aren’t following the strict basis you need to make sure you remember to include everything that left your ownership during the year, at the right price to get the right resulting figure to claim as an expense.
New businesses and Pre-Trading Expenses
As some of you will be aware, you are allowed to claim eligible expenses that you incurred in the seven years before your Commencement Date of your new business (there’ll be a post specifically on this later in the Series).
If you bought raw materials or items for reselling before your commencement date (ie in the 7 years before your business started) you include them as Stock Added as though you bought them on the very first day of trading ie your Commencement Date. You don’t include them as your Opening Stock, your Opening Stock is zero. If they were gifted or bartered, you follow the same rules outlined above for their value.
This means that these pre-trading purchases of stock are treated exactly the same way as any other purchases of stock, eligible for tax relief only when they’ve been made into something and sold or otherwise disposed out of your business.
Appropriations - taking stock for your own use
Appropriations happen when the business owner takes any of his stock for his own (or his family’s) personal use (which includes because you're giving it away to someone else as a present). There is a special box for them called ‘Goods and services for your own use’ in the ‘Calculating Your Taxable Profit & Loss’ in both the Full and the Short Self-Employment pages of your tax return.
I’m including them here because although they go in a different place on the Return to expenses, they affect your stock levels.
If you’re following the strict basis for stock, once you take raw materials or a finished product out of your stock, it doesn’t feature in the annual stocktake, and therefore the appropriation is automatically reflected in the final answer of what’s been used. If you aren’t following the strict basis for stock, you need to remember to add the cost value of appropriated stock to the value of goods used figure you declare to HMRC (either in the Full pages as a specific number, or as part of the Total Expense figure for the Short pages). That deals with the expense side of the Appropriation.
But, you also need to deal with the fact that you’ve just taken the item(s) out of stock on the income side as well. And HMRC rules say that you have to treat an Appropriation as being of market value ie the price anyone else would have paid you if they took the item(s) from your stock. No cash changes hands, because you are the business owner & sole trader, the Appropriation is another example of a ‘ghost’ number that you need to use for the Accruals basis, but which doesn’t represent real cash. You put the value of the Appropriated items in the special ‘Goods & Services for your own use’ box.
The effect of taking the Appropriation materials cost out of the Stock side and adding the Appropriated finished item’s sale ‘ghost’ price into the special box as 'ghost' income, is that the difference between the two, which would have been your profit if it had been a real sale, is treated as ‘ghost’ profit subject to tax, even though you never actually had the cash in your hands.
Using stock for marketing
If you sometimes use small finished products or supplies and put them in with a sold item as a marketing freebie for a buyer or similar, then it is not an appropriation for the owner's private use.
If you are following the strict basis for Stock, then the fact that these items are no longer in your stock means that your using them for freebies/ marketing has automatically been accounted for. If you aren't following the strict basis then you need to remember to include the cost Stock value of these items in the 'cost of goods used' expense claim in your tax return.
Personally, I feel that following the strict basis for Stock, once it's set up, makes it much easier for a small craft business to get the Stock expense figure correct each year; than to try and remember all the ad hoc transactions that didn't involve cash during the Trading Period and to make sure you're claiming the right amounts at the right time.
- Full Self-Assessment Pages and Notes here
- Short Self-Assessment Pages and Notes here
- Helpsheet 222 here
- HMRC Manual: about Stock & Work In Progress here, about Appropriations here
Featured Seller: PoppySparkles (Viv Smith) is a self-taught jewellery artist and owner of Poppy Spakles, based on the Fylde Coast, near Blackpool, UK. She creates jewellery for young and old(er) girls using Freshwater pearls, Swarovski Crystal, gemstones and sterling silver. Her work predominantly focuses on birthstone jewellery, providing the perfect keepsake gift for babies, baptism, birthdays and for New Mums. Bespoke requests are welcome. Find her work at www.PoppySparkles.etsy.com