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Valuation of Stocks – Accounting and Tax Aspects

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The proper valuation of stocks, especially of goods sold, is critical for correct accounting and tax profit calculation. Indeed, this difference between revenue and cost of goods gives the gross margin.


In an industrial company, inventories consist of the following:

  • Raw materials, packaging, and other materials
  • incorporated into the finished product,
  • Products “in-process”,
  • Finished products ready for sale,
  • Saleable by-products.

Determination of the cost of production of finished products:

The total manufacturing cost is the sum of the inputs used to manufacture the finished product. Tax regulations and accounting principles require that all expenses incurred during the production period be recorded as costs of production of finished goods or products “in process”. In summary, these are the purchase cost of raw materials up to delivery, (that is to say, including freight, insurance, customs clearance, etc ….) wages, social charges and other benefit contributions for staff, and “indirect” costs of production.

Regulations define the costs of raw materials and labor as direct costs.

Other costs considered as “indirect” costs of production are:

  • Depreciation of assets used in the production process,
  • Auxiliary services such as accounting departments, purchasing, logistics, HR, security, cleaning and equipment maintenance, etc…
  • Cost of fire insurance for the production plant,
  • Utilities expenses such as electricity, water, gas, phone, fax, etc…
  • Amortization of software used in the production process.


The establishment of a system for the accurate calculation of the costs of production of goods and services meets three requirements.

a) Compliance with the Law of PLC companies:

Law No. 6404, known as the PLC Companies Act, but also applicable to other types of companies, requires that the accounting entries are made in accordance with generally accepted accounting principles in Brazil.

However, the method of calculation of costs of production that respects these accounting principles is the one called “by absorption”. Under this method, all production costs, direct and indirect, should be included in the cost of the finished products.

b) Compliance with Tax Law:

Brazilian tax law requires of the company to maintain an integrated cost management system, linked with the general ledger. This requires a formalization of cost accounting by:

  1. A cost analysis system,
  2. Classification and accounting,
  3. Information generation and edition of management reports on costs of production.

c) Addressing the needs of management:

The introduction of cost accounting, which aims to provide the management with information necessary for controlling the activity – including the monitoring of profit margins – is key to the success of any business. With such a system, the issue is not complying with local accounting principles or fiscal constraints, but bringing to the management reliable and relevant information.

The calculation of costs must be supported by figures of general accounting, and must allow the monthly calculation of the value of stocks.

In the calculation of income tax and social contributions, the only accepted method of calculating costs of production is the method “by absorption”.

In the absence of the integrated system of calculating costs “by absorption”, the tax authorities may make an arbitrary assessment of stocks of finished and in-process goods.


In general, non-cumulative taxes that can be recovered should not be included in the cost of goods or raw materials purchased.

Example of a trading business – recoverable ICMS:

A trading company acquires goods for 1,000,000 R$, including 180,000 R$ of ICMS, plus an additional 100,000 R$ of IPI (10%).

Recording the Purchase:

Goods for resale: 920,000
ICMS recoverable: 180,000

Suppliers: 1,100,000

The ICMS is not included in the cost of goods and can be recovered or offset with the ICMS due on the sales.

In trading enterprises, according to the illustration above, the amount of IPI includes the acquisition cost of goods because the IPI is not due on the resale of goods.

Example of an industrial company – ICMS and recoverable IPI:

An industrial company acquires raw material for 1,000,000 R$, including 180,000 R$ of ICMS, plus an additional 100,000 R$ of IPI (10%).

Recording the sale:

Raw materials stocks: 820,000
ICMS recover able: 180,000
IPI recoverable: 100,000

Suppliers: 1,100,000

Here, neither IPI nor ICMS integrate the accounting cost of raw materials, because these two taxes can be recovered or compensated with ICMS and IPI collected on sales.



Brazilian regulations permit the use of average cost, or the First-In/First-Out (FIFO) method, to assess the value of inventories. The Last-In/First-out (LIFO) method is not accepted.VALUATION OF “INCOMING” PRODUCTS

There are two methods of valuation of stocks:

  •  The actual cost method by absorption,
  •  The lump sum tax method.

With the actual cost method “by absorption”, the cost of production must include:

  • the cost of raw materials, packaging and other products consumed in the manufacturing process,
  • the cost of labor used – salaries and benefits – including that relating to the supervision, handling and safety of the production site,
  • rental costs, maintenance expenses, and the depreciation of assets used in the process of production,
  • the amortization of assets directly used in the process of production, such as dedicated software.

The lump sum tax method:

For finished products: with this method, the cost of production of finished products will be estimated at 70% of the maximum sales price applied during the tax year.

For stocks of in-process goods: the taxpayer may choose to assess the value of in-process goods, either on the basis of the cost of raw materials purchased, or on the basis of the market prices of the finished products:

  •  the cost of in-process goods must be equal to 1.5 times the maximum cost of raw materials purchased during the year, or,
  •  the cost of in-process goods must equal 80% of the value of finished products. Because the value of finished products is estimated at 70% of the selling price, the cost of in-process will be 56% (that is to say 80% of 70%) of the maximum selling price of the period.


The Brazilian Treasury requires all companies using the ‘Real’ method of profit calculation, to conduct a physical inventory. If there is a permanent inventory, then the physical counting can be made at any time during the year. If, however, there is no permanent inventory, then this counting should be performed at the year end.

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