The number you sign off on your stock sheet at the year end is the number you pay tax on. Trading profit is computed on the accounts figure, under ITTOIA 2005 s.25(1) for a sole trader or partnership and the identical rule at CTA 2009 s.46(1) for a company, and there is no separate tax code for valuing what is sitting in your racks. So if you cannot build up what one unit costs, you cannot defend your closing stock, and if you cannot defend your closing stock you are guessing at your taxable profit.
The way to fix that is to build the cost of one product line by line and then follow it all the way to the tax bill. That is what the rest of this page does, using Tessa, who runs a small aluminium casting and machining company in Kendal making brackets for equipment manufacturers. Every figure below is recomputable from the figures printed next to it.
Building one bracket's cost, line by line
Tessa's company makes a cast bracket. The cost card has four blocks: materials, labour, absorbed overhead, and the scrap and rework allowance that most cost cards leave out.
Direct materials. Each bracket takes 2.4 kg of aluminium at £3.75 a kilogram, which is £9.00, plus £1.20 of fixings and finishing consumables. Direct materials are £10.20.
Note that the 2.4 kg is the usage figure, not the net weight of the finished part. Runners, risers and machining swarf are consumed to make the bracket, so they belong in the material cost of the bracket, not in a separate wastage line that quietly never gets allocated to anything.
The hourly labour rate that goes on the cost card
A machinist on £32,000 does not cost the company £32,000. Build the loaded cost first:
| Line | Calculation | Amount |
|---|---|---|
| Gross salary | £32,000.00 | |
| Employer National Insurance (15% above the £5,000 secondary threshold, from 6 April 2025) | 15% x (£32,000 - £5,000) | £4,050.00 |
| Employer pension at the 3% auto-enrolment minimum on qualifying earnings (the £6,240 to £50,270 band, 2025/26 figures, still current when this page was checked in August 2026) | 3% x (£32,000 - £6,240) | £772.80 |
| Loaded annual cost | £36,822.80 |
Now divide by productive hours, not paid hours. After holiday, training, maintenance downtime and the hours the machinist spends setting rather than cutting, Tessa gets 1,600 productive hours a year out of that person. £36,822.80 divided by 1,600 is £23.01 an hour. Each bracket takes 0.25 of a labour hour, so direct labour is 0.25 x £23.01 = £5.75.
Dividing by 1,850 paid hours instead would have given £19.90 an hour and £4.98 a bracket, understating the cost of every unit in stock by 77 pence. On the closing stock figures further down this page that alone would misstate the year-end position by several thousand pounds.
Absorbing production overhead: normal capacity for fixed, actual usage for variable
Production overhead has to be absorbed into cost, and the split is prescribed rather than optional. HMRC's guidance at BIM33135, following FRS 102 Section 13 Inventories, allocates fixed production overheads on normal production capacity and variable production overheads on actual usage.
Tessa's annual fixed production overhead:
| Fixed production overhead | Annual |
|---|---|
| Factory rent and rates | £24,000 |
| Depreciation of production plant | £18,000 |
| Production supervision | £34,000 |
| Fixed element of heat, light and power | £8,000 |
| Total fixed production overhead | £84,000 |
Normal capacity for the machining cell is 12,000 machine hours a year. £84,000 divided by 12,000 gives a fixed absorption rate of £7.00 per machine hour. Variable overhead (tooling consumables, indirect materials, the metered power draw) runs at £2.50 per machine hour on actual usage.
Each bracket occupies 0.4 of a machine hour. Fixed overhead is 0.4 x £7.00 = £2.80 and variable overhead is 0.4 x £2.50 = £1.00, giving £3.80 of absorbed overhead per bracket.
The normal-capacity rule is the one that bites in a bad year. If Tessa's cell only runs 9,600 machine hours, the absorbed fixed overhead is 9,600 x £7.00 = £67,200 against £84,000 actually incurred. The £16,800 under-absorbed is charged as an expense of the period. It cannot be loaded into the rate and carried forward in closing stock, which is exactly the manoeuvre the rule exists to prevent.
Scrap and rework: the two lines most cost cards leave out
Four per cent of brackets started are scrapped at final inspection with no recovery. That means the cost of the units Tessa binned has to be carried by the units she sells. The good-unit subtotal so far is £10.20 + £5.75 + £3.80 = £19.75, and grossing up for scrap gives £19.75 / 0.96 = £20.57.
Three per cent of good units need 0.1 of a labour hour of rework: 0.03 x 0.1 x £23.01 = £0.07 a unit.
| Cost card, one bracket | Amount |
|---|---|
| Direct materials (2.4 kg at £3.75, plus £1.20 consumables) | £10.20 |
| Direct labour (0.25 hr at £23.01) | £5.75 |
| Absorbed overhead (0.4 machine hr at £7.00 fixed plus £2.50 variable) | £3.80 |
| Subtotal before scrap | £19.75 |
| Scrap gross-up (÷ 0.96) | £20.57 |
| Rework allowance | £0.07 |
| Cost per good bracket | £20.64 |
That £20.64 is now doing two jobs at once. It tells Tessa whether her £27.50 selling price works, and it values every finished bracket on her shelves at the year end.
Part-finished batches carry overhead too
Work in progress (WIP) means production that has started and not finished. HMRC notes at BIM33020 that the term covers three different things: part-finished manufactured product, service contracts, and long-term construction contracts. Only the first is a stock valuation question for a factory. Long-term contracts are a revenue-recognition question and follow a different route entirely, so if you build to order over many months, treat that as a separate conversation and date-check the position, because the accounting standard in that area is in the middle of a change.
For manufactured work in progress the basis is the same as finished goods, applied to the stage reached. At Tessa's year end, 2,500 brackets have been cast and machined but not finished, inspected or packed. Material is fully issued; labour and machine time are 60% complete.
| Work in progress, one bracket | Calculation | Amount |
|---|---|---|
| Direct materials (fully issued) | £10.20 | |
| Direct labour at 60% | 0.15 hr x £23.01 | £3.45 |
| Fixed overhead at 60% | 0.24 machine hr x £7.00 | £1.68 |
| Variable overhead at 60% | 0.24 machine hr x £2.50 | £0.60 |
| Cost per unit of work in progress | £15.93 |
2,500 units at £15.93 is £39,825. Valued at materials only, the same batch would have come in at £25,500, understating stock by £14,325 and understating taxable profit by the same amount. That is the single most common correction on a manufacturing stock sheet.
Lower of cost and net realisable value
Cost is only half the test. Stock is carried at the lower of cost and net realisable value (NRV), meaning the amount you expect to get for it less the costs of getting it sold.
Tessa has 6,000 finished brackets, of which 800 were made for a customer that cancelled. They are a non-standard variant she now expects to move at £14.00 each, with £1.50 a unit of selling and repackaging cost, so net realisable value is £12.50 against a cost of £20.64. The write-down is 800 x (£20.64 - £12.50) = £6,512.
| Closing stock and work in progress at 31 March 2027 | Amount |
|---|---|
| Finished goods, 6,000 at £20.64 | £123,840 |
| Work in progress, 2,500 at £15.93 | £39,825 |
| Write-down of 800 units to net realisable value | (£6,512) |
| Closing stock and work in progress | £157,153 |
The write-down has to be a genuine expectation about what the goods will fetch, evidenced at the year end. It is not a discretionary provision you dial up in a good year, and last in, first out is not available as a method at all: HMRC states at BIM33100, following the Anaconda case, that LIFO is not allowable for tax.
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From closing stock to taxable profit: Tessa's bridge
A cost card is an accounting number, never a tax computation. Two adjustments stand between them.
First, the depreciation absorbed into that £7.00 fixed overhead rate is capital expenditure written off over time, and capital expenditure is not deductible. It is added back in the tax computation, and capital allowances are substituted for it: the Annual Investment Allowance of £1,000,000 a year, the 40% first-year allowance on new and unused main-rate plant from 1 January 2026, and writing-down allowances at rates that changed in 2026. Which allowance to point at which machine, and how a straddling year end is handled, is set out on our page on capital allowances for manufacturers.
Second, the movement in stock and work in progress lands on taxable profit pound for pound, because goods still in the racks have not yet been matched against a sale.
| Year to 31 March 2027 | Amount |
|---|---|
| Opening stock and work in progress at 1 April 2026 | £141,000 |
| Closing stock and work in progress at 31 March 2027 | £157,153 |
| Increase carried in the profit figure | £16,153 |
| Profit before tax per the accounts (after that movement) | £120,000 |
| Add back depreciation charged in the year | £18,000 |
| Deduct capital allowances claimed | (£45,000) |
| Taxable profit | £93,000 |
Corporation tax on £93,000 for the financial year beginning 1 April 2026: profits sit between the £50,000 lower limit and the £250,000 upper limit, so the main rate of 25% applies with marginal relief at the standard fraction of 3/200. That is (25% x £93,000) minus (3/200 x (£250,000 - £93,000)) = £23,250 - £2,355 = £20,895. Both limits are divided by the number of associated companies and time-apportioned for a short period, so a second company in the group changes this arithmetic before anything else does.
Now the reason the stock sheet matters. Had Tessa carried the 800 cancelled-order brackets at full cost and missed the £6,512 write-down, taxable profit would have been £99,512 and the tax £22,620.68, which is £1,725.68 more. That is £6,512 at the 26.5% effective marginal rate that applies between the two limits. A stock decision made in half an hour with a clipboard moved the tax bill by more than the cost of the stock count.
Where the cost per unit actually moves
Once the build-up exists, "reduce manufacturing costs" stops being a slogan and becomes arithmetic. Each row below changes one input on Tessa's card and leaves the rest alone.
| Change | New cost per good bracket | Saving |
|---|---|---|
| Aluminium price down 10% (£3.75 to £3.375 a kg) | £19.71 | £0.94 |
| Scrap rate halved, 4% to 2% | £20.22 | £0.42 |
| Cycle time down 10% (0.4 to 0.36 machine hours) | £20.25 | £0.40 |
| Rework eliminated entirely | £20.57 | £0.07 |
The material row saves £0.94 even though the price cut is only worth £0.90 of material, because the scrap gross-up divides by 0.96 and amplifies every upstream saving. The rework row is the one that surprises owners: it is the failure everybody can see on the shop floor and it is worth seven pence. Attack the lines in the order the arithmetic gives you, not the order the noise gives you.
Eight costing failures that change a tax bill
- Work in progress valued at materials only. Part-finished production carries absorbed conversion cost. On Tessa's numbers that error is £14,325 of understated stock and understated profit.
- Labour divided by paid hours. Setting, downtime, training and holiday are not productive hours; using them inflates capacity and deflates unit cost.
- Employer National Insurance and pension left out of the hourly rate. They add £4,822.80 to a £32,000 salary, roughly 13% of the loaded rate.
- Fixed overhead absorbed on actual output in a slow year. Under-absorbed overhead is a period expense, not a stock asset.
- Scrap treated as a variance rather than a cost. If bad units are not carried by good units, every quoted price is understated.
- Net realisable value never tested. Slow-moving and cancelled-order stock sits at full cost, and the relief is lost in the year it belongs to.
- Standard costs that have not been reviewed since the last price rise. A cost card built on last year's metal price values this year's stock wrongly in both directions.
- Depreciation treated as the tax deduction. It is added back; capital allowances are the deduction, and the two figures are rarely close.
If you trade as a sole trader or partnership
The worked example above is a company, and one point does not carry across automatically. Cash basis accounting is now the standard way for a sole trader or partnership without corporate partners to record income and expenses, and on the cash basis there is no year-end stock and work in progress valuation at all, because the accounts-based rule in ITTOIA 2005 s.25(1) is switched off for a trade using it. Limited companies cannot use the cash basis and are always on accruals.
So an unincorporated manufacturer that wants absorption costing to drive its tax number has to be on the accruals basis, having elected out of the cash basis. Every stock-driven figure on this page assumes accruals accounting. If you are unincorporated and unsure which basis your last return was filed on, that is the first thing to check, because it decides whether any of the stock arithmetic here applies to you.
Costing and stock: what to do before your year end
Count and value at the same time. A stock count that records quantities and leaves valuation to a spreadsheet three weeks later loses the condition evidence that supports every write-down. Record the stage of completion of each work in progress batch on the count sheet, photograph damaged or obsolete items, and keep the price evidence behind any net realisable value figure.
Then check the cost card against the year's real numbers: actual material prices, actual loaded pay rates, actual machine hours against normal capacity. A cost card is only as good as its most recently reviewed input, and it is now valuing an asset that appears on your tax return.
The two pages either side of this one
The wider factory finance function, from corporation tax and VAT through to the payroll cost of a shop-floor hire, is covered on our page for accountants for manufacturers. The machinery side of the bridge above, including the dated 2026 allowance changes and which relief to claim first, sits with capital allowances for manufacturers. Food and drink producers have an extra layer, because the VAT liability of the output governs the shape of the whole business, and that is set out separately for food and drink manufacturers.
If your closing stock figure is currently a spreadsheet nobody wants to defend, talk to us. Building the cost card once is a week's work and it settles the valuation question for every year after it.