1931 BTA LEXIS 2261 | B.T.A. | 1931
Lead Opinion
The issue raised by these proceedings is whether the respondent was justified in rejecting the returns for the years in controversy, which purported to show net income computed according to the cash receipts and disbursements method of accounting, and recomputing net income according to the completed-contract method as prescribed by subparagraph (b) of article 36, Regulations 62, 65, and 69. As an alternative issue the petitioner charges the respondent with error in including in income for 1926 the net gains from four certain projects which were completed in 1925.
The petitioner contends that his books of account were kept according to the cash receipts and disburséments method of accounting; that net income is clearly reflected by that method; that the net income reported in each of the returns was correctly computed according to the cash receipts and disbursements method; and, consequently, that the respondent is wrong in rejecting the returns and recomputing net income according to the completed-contract method. Failing in these respects, the petitioner contends that the completed-contract method of computing net income, as prescribed by the regulations, is not authorized by law, and that, because of certain deficiencies in the accounting records, it is impossible to determine the net income according to any accounting method authorized by law other than the cash receipts and disbursements method.
The respondent contends that the petitioner regularly employed the completed-contract method in keeping his books of account; that such method clearly reflects the petitioner’s net income; and that, consequently, the petitioner is barred from using any other method of computing net income for the purposes of the income tax.
The statutes which are controlling in the decision of the issue here raised are the Revenue Acts of 1921, 1924, and 1926. Section
The petitioner contends that his books were kept according to the cash receipts and disbursements method, but this is not supported by the evidence. In the course of our study of this case we have made a careful examination of petitioner’s books, submitted in evidence, and we have found numerous instances of the accrual of items of expense and income in the primary accounts. The cost of materials purchased for a project was entered in the purchase ledger and from there posted to the project account without regard to the time of petitioner’s payment for the materials. Compensation due petitioner under contracts has been credited to project accounts, without regard to the time of receipt, before the project accounts were closed out into the “ income account.” The petitioner’s own expert witness, a certified public accountant, testified that the books were kept on a hybrid basis, partly cash receipts and disbursements and partly accruals; but his testimony would have more fairly represented the situation had he stated, or added, that with few unimportant exceptions, the primary accounts were kept on an accrual basis.
It is entirely clear from the books, however, that the petitioner’s accounting practice was formulated with the objective of postponing an accounting of the gain or loss on each project until the project had been completed. We have not found in the “ income account ” or the profit and loss account a single entry intended to record a gain or loss on any project prior to completion. Considering the objective of the petitioner’s accounting practice, the method of keeping the primary accounts was not important. They could be kept on either a cash receipts and disbursements basis, or on an accrual basis, or on a hybrid basis, without creating any impediment in attaining the objective, since the entries in those accounts were used to ascertain gains and losses on the projects to which they related only when the projects had been completed. It did not matter whether costs were recorded in the primary accounts when
The petitioner’s returns were not prepared in accordance with the method of accounting regularly employed in keeping his books; nor does the method of accounting used in computing the net income in the returns clearly reflect the petitioner’s net income. On his books, gains and losses have been recognized and accounted for only when the projects were completed. In each return the petitioner has computed gains and losses on projects completed in a prior or subsequent year. In computing net income in each return, the petitioner has deducted, as expenses, all cash expenditures, other than for additional construction equipment, made during the year, and has included in income all cash received during the year as compensation from contracts. As a result of this method of computing net income, the return for 1923 reflects net losses on certain projects, amounting to $80,844.65, while the return for 1924 reflects net gains on the same projects, amounting to $61,530.38; and the return for 1924 reflects net losses on certain projects, amounting to $22,007.66, while the return for 1926 reflects net gains on the same projects, amounting to $7,603.98. Obviously, any method of accounting, by whatever name one chooses to identify it, that is capable of and does produce results such as this is not a proper method of computing net income for the purposes of the tax. Net income is not clearly reflected by reporting losses of $80,000 in one year and gains of $67,000 in the next, all in respect of the same projects. Each project has a definite result, either a gain or a loss, which is not determinable until the project is completed. Washington Land Co., 10 B. T. A. 503. Since the method of accounting used in computing net income in the returns was not the same as was regularly employed in keeping the petitioner’s books and does not clearly reflect income its use for computing net income for the purposes of the tax is clearly prohibited by statute.
Another reason suggested by the accountant for the inability to correctly determine net income according to the completed-contract method, is the failure of the bookkeeper to close the project accounts into “ income account ” at any fixed time, sometimes the project
Still another reason suggested by the accountant for the inability to correctly determine net income on the completed-contract basis is the petitioner’s failure to inventory materials and supplies on hand at the end of such year, which the accountant deems essential to the determination of the “ cost of goods sold.” The answer to that is that there is no proof that the petitioner had any materials and supplies on hand at the close of the years in controversy which had not been purchased for particular projects and charged against project accounts. Such materials are in the same category as “ goods on hand or in process of manufacture for deli ver y under firm sales contracts * * * at fixed prices,” which, under article 1584 of Regulations 62 and article 1614 of Regulations 65 and 69, are to be inventoried at cost; and the materials having been charged to the project accounts at cost, the same accounting end has been served as though they had been charged to an inventory account instead. Finally, it is contended by the petitioner that the completed-contract method of computing net income, as prescribed by article 36 of Regulations 62, 65, and 69 is not authorized by statute and is, therefore, invalid. . The same contention was made in James C. Ellis et al., 16 B. T. A. 1225, in which case the Board held that “ the regulation in question is designed to reflect income from long-term contracts, and we are unable to perceive that it is inconsistent with or is not authorized by law.” We see no good reason to change our views in the instant case. See also In re Harrington, 1 Fed. (2d) 749.
It is our opinion that the petitioner’s books of account were kept according to the completed-contract method of accounting, and that his net income is clearly reflected by that method. It was mandatory upon the petitioner, under the applicable statutes, to compute his net income for the purposes of the tax according to the same
On the alternative issue, the petitioner is clearly entitled to prevail, though not in the whole amount claimed. The evidence is clear and unmistakable that the projects described as “Jermyn Bank,” “Mayfield State Bank,” “St. Johns Church,” and “D. L. & W. Tower ” were completed in 1925. Under the petitioner’s method of accounting the profits from these projects constituted income for 1925; and, since such profits have been included by the respondent in income for 1926, the net income of that year, as shown by the deficiency notice, should be reduced by the sum of $31,774.64.
Judgment mil be entered under Rule 50.