*3616 1. Petitioner's inventory was originally priced by one who was familiar with the cotton which he was pricing, and who was in a position to compare the respective values of similar cotton offered by different brokers under different trade names. Held, that the inventory as originally taken was more nearly correct than any which could now be arrived at on the basis of the opinion testimony and should not be disturbed.
2. The machinery in petitioner's mill was operated in excess of the normal daytime operation during the years in question. Held, that 7 per cent is a fair allowance for depreciation in each of the years involved.
3. Petitioner shortly prior to the date of taking its inventory of goods in process had a general reduction in wages. Held, that in arriving at the market value of such goods the item of labor should go into the computation at prices prevailing at the date of the inventory.
4. It was customary for petitioner to take orders in advance under blanket contracts which provided for a gross number of pounds of yarn, to be selected at the option of the purchaser, from a number of sizes or counts, to be specified in shipping directions to be*3617 forwarded later. Held, that yarns in process or finished yarns, suitable for delivery on contracts upon which specifications had been received at the date of inventory should be valued at cost and the balance at market, which was less than cost.
*38 The Commissioner determined deficiencies in income and profits taxes for the calendar years 1917 to 1920, inclusive, as follows:
| Deficiency | Overassessment | |
| 1917 | $36,753.47 | |
| 1918 | $15,007.83 | |
| 1919 | 33,592.44 | |
| 1920 | 150,670.84 | |
| Total | 221,016.75 | 15,007.83 |
The petitioner instituted this proceeding for a redetermination of its tax and alleges that the Commissioner committed error (1) in valuing the inventories of goods in process and finished goods as at December 31, 1920, at cost instead of market; (2) by refusing to allow adequate depreciation in the years 1917 to 1920, inclusive, to cover the excessive wear, tear and exhaustion of machinery due to overtime operation; and (3) in determining the fair market value of cotton and cotton waste included*3618 in the petitioner's inventory of raw materials at December 31, 1920.
The overassessment of $15,007.83 for the year 1918 does not come within the jurisdiction of the Board and is not considered.
FINDINGS OF FACT.
Petitioner is a Rhode Island corporation with principal office at South Attleboro, Mass. It is engaged in the manufacture of cotton yarn. This yarn is made from four principal classes of raw material: (1) entirely from domestic cotton, which is commonly called peeler cotton; (2) from a combination of peeler cotton and peeler waste; (3) entirely from foreign cotton; and (4) from a combination of foreign cotton and foreign waste. The inventory at December 31, 1920, contained raw cotton and waste in bales, yarn in process of manufacture, and finished yarn.
Cotton is graded according to the length of fibre or staple, by the color and by the quantity of dirt or trash which it contains. Merchants and brokers customarily deal in the various grades of cotton under certain distinctive names called types. Petitioner's inventory of raw material at December 31, 1920, was taken and valued under these types, with the exception of certain lots which had been purchased on*3619 actual sample. The petitioner used only long staple, white cotton.
During the latter half of 1920 there was a decline in the market value of cotton. Beginning in May the trend of the market was decidedly downward, except for daily fluctuations, until the end of December, 1920, when the low level of prices for the year was reached.
*39 The value of its raw material inventory as determined by the petitioner at December 31, 1920, was as follows:
| Raw cotton (all grades) | $488,418.19 |
| Purchased waste (all grades) | 80,861.04 |
| Total | 569,279.23 |
This value was used in petitioner's original tax return for 1920 and was accepted by the respondent in the notice of deficiency.
The quantities of cotton of various types, and the market value of each type as set out in the original inventory and accepted by the Commissioner in determining the deficiency were as follows:
| Type or sample | Pounds of cotton | Market values per pound |
| peeler cotton | Cents | |
| BOAZ | 38,750 | 0.24 |
| DUKE | 104,707 | .27 |
| JESS | 56,394 | .27 |
| ARKS | 99,583 | .19 |
| EULA | 22,848 | .24 |
| TOMY | 79,981 | .27 |
| GOLD | 39,943 | .19 |
| JOHN | 135,581 | .19 |
| JAKE | 2,198 | .24 |
| ISLEY | 35,793 | .19 |
| LOTE | 4.129 | .24 |
| SHIP | 4,271 | .24 |
| MYRA | 8,159 | .27 |
| X8BJ | 26,243 | .19 |
| GXNC | 36,186 | .24 |
| HUMB | 71,313 | .19 |
| IDAH | 84,152 | .24 |
| TERK | 64,801 | .19 |
| ADAM | 46,786 | .19 |
| BNOX | 24,474 | .27 |
| SAAC | 24,007 | .21 |
| SIUM | 11,746 | .21 |
| SODS | 1,213 | .21 |
| ATIO | 55,053 | .24 |
| DVMN | 41,443 | .24 |
| FORY | 28,129 | .19 |
| HANA | 42,874 | .24 |
| FOOD | 23,883 | .24 |
| JAZZ | 23,447 | .27 |
| PABJ | 38,222 | .24 |
| NSPU | 24,195 | .24 |
| TILE | 31,434 | 0.24 |
| VETH | 24,997 | .27 |
| 1,356,935 | ||
| Foreign cotton | ||
| Haitian | 108,150 | .21 |
| Sak | 159,652 | .37 |
| Egyptian | 155,991 | .21 |
| Mexican | 62,268 | .19 |
| Peruvian | 19,069 | .21 |
| Santo Domingo | 243,954 | .21 |
| 749,084 | ||
| Peeler cotton waste | ||
| White spinners | 13,597 | .12 |
| Unknown | 9,421 | .12 |
| 23,018 | ||
| Foreign waste | ||
| Egyptian strips | 157,404 | .12 |
| Sak strips | 230,820 | .12 |
| Sak spinners | 57,407 | .12 |
| Mixed spinners | 200,039 | .12 |
| Unknown | 5,154 | .12 |
| 650,824 |
*3620 The market value of the raw cotton and purchased waste in petitioner's inventory at December 31, 1920, was that assigned to it by petitioner as set out above. In each case market value was less than cost.
Petitioner's inventory at December 31, 1920, contained goods in process and finished yarn as follows:
| DEPARTMENT | |
| In process in carding department: | Pounds |
| Peeler | 24,325 |
| Peeler and waste | 61,694 |
| Foreign | 14,120 |
| Foreign and waste | 11,066 |
| 111,205 | |
| Finished carding: | |
| Peeler | 16,300 |
| Peeler and waste | 12,560 |
| Foreign | 6,100 |
| Foreign and waste | 1,700 |
| 36,660 | |
| ,In process in spinning department: | |
| Peeler | 9,116 |
| Peeler and waste | 11,753 |
| Foreign | 1,708 |
| Foreign and waste | 2,801 |
| 25,378 | |
| In process in finished department: | |
| Peeler | 54,859 |
| Peeler and waste | 44,926 |
| Foreign | 9,785 |
| Foreign and waste | 13,644 |
| 123,214 | |
| Finished yarn: | |
| Peeler | 96,925 |
| Peeler and waste | 86,581 |
| Foreign | 18,652 |
| Foreign and waste | 24,197 |
| 226,355 |
*40 Petitioner valued such goods in process and finished yarns in its inventory at December 31, 1920, at $225,271.72. In computing the inventory of goods in process and finished yarns at December 31, 1920, the*3621 respondent disregarded this valuation and valued goods in process and finished yarn on the basis of cost.
On December 20, 1920, petitioner put into effect a general wage reduction averaging 22 1/2 per cent of the scale of wages which had been effective during the three months period preceding that date.
It was the petitioner's practice to bid for the customer's business, and, if successful, to send them regular printed contract forms asking that one be signed and returned to it. These contracts show the approximate time delivery is to begin. Some provided for only one size and kind of yarn, while others were blanket contracts for an aggregate quantity of yarn to be supplied from a number of different sizes at specified prices for each size, upon specification to be furnished thereafter by the customer. Under these blanket orders the customer could specify the entire quantity on order from one size or could distribute it among the various sizes and kinds as he required. Prior to the receipt of these specifications it was impossible to determine *41 what sizes or kinds of yarn were covered by the unfilled portion of the blanket contracts.
It was the petitioner's practice*3622 to manufacture for stock such kinds of yarn as in its judgment might be required. In cases where yarn was manufactured for stock it could not be allocated to any particular order until specifications were received.
On December 31, 1920, petitioner had on hand unfilled contracts for 230,376 pounds of yarn, of which 101,023 pounds were covered by specifications on hand at that date. These were divided as follows:
| Contract | Specifications | |
| Pounds | Pounds | |
| Peeler cotton yarn | 61,264 1/2 | 45,761 1/2 |
| Peeler cotton and waste yarn | 98,990 | 39,044 |
| Foreign cotton yarn | 70,121 1/2 | 16,217 1/2 |
| 230,376 | 101,023 |
Petitioner began the operation of its plant about the middle of the year 1912. At that time, with a very few exceptions, all its machinery was new. The cost of machinery at the end of each year was as follows:
| 1916 | $349,603.61 |
| 1917 | 617,652.26 |
| 1918 | 695,331.87 |
| 1919 | 767,613.47 |
| 1920 | 775,647.22 |
For the years in question the respondent allowed a composite rate of depreciation of 6 per cent on all machinery on hand at the beginning of the year and one-half of this rate for all machinery acquired during the year. During each*3623 of these years the petitioner's mill operated with night shifts in addition to the normal daytime operation. The mill was operated in excess of the normal daytime operation for the years in question as follows:
| Year | Per cent of normal daytime operation |
| 1917 | 32.32 |
| 1918 | 32.94 |
| 1919 | 40.61 |
| 1920 | 35.39 |
The night operators did not take as good care of the machinery as the day operators.
A reasonable allowance for depreciation of such machinery, including obsolescence thereof, is an amount equal to 7 per cent of the cost of machinery on hand at the beginning of the year and 3 1/2 per cent of the cost of machinery acquired during the year.
*42 OPINION.
PHILLIPS: The first question presented to us for determination is the value of the raw materials inventory of the petitioner on December 31, 1920. Petitioner's inventory was made up of both domestic and foreign cottons and domestic and foreign waste. The cotton is identified by symbols or marks indicating the type and grade of cotton. This inventory was prepared under the supervision of the general manager of the petitioner who purchased practically all of its cotton and who, therefore, knew the qualities*3624 of the cotton indicated by each mark. This inventory was also priced by him and although he had made no purchases during the latter part of the year 1920 and was somewhat out of touch with the market, his testimony is that inventories were based upon quotations which he had received over a period of a week or two previous to the time the value was set. This witness had purchased all of the cotton of the petitioner since the year 1912 and, in consultation with the treasurer, had priced all of its inventories since that time. The inventory of raw materials so made by the petitioner was used by it in its income-tax return and was accepted as correct by the respondent. The petitioner claims that such inventory was overstated by some $75,000.
In support of its claim the petitioner offers the testimony of various dealers who had sold cotton to the petitioner of the various types included in the inventory. Each witness confined his testimony to his opinion of the value on December 31, 1920, of the particular cotton sold by him and bearing the descriptive mark used by him in selling such cotton. Apparently no two of such witnesses used the same marks for the same kind of cotton. No*3625 two dealers attempted to testify as to the value of any cotton bearing a particular mark; in other words, we have the expression of opinion of only one dealer as to the value of cotton identified by a particular mark or as a particular type.
The domestic cotton included in the petitioner's inventory is identified under 33 separate marks. The opinion expressed by the dealer in each particular type of such cotton compares with the value used in the petitioner's inventory as follows: In the case of 5 types the values are the same; in the case of 16 types it is 1 cent per pound less; in the case of 1 type it is 1 1/2 cents less; in the case of 1 type it is 2 cents less; in the case of 1 type it is 3 cents less; in the case of 1 type it is 4 cents less; in the case of 1 type it is 2 cents more and in the case of another type it is 5 cents more. In the two cases where the values are 3 and 4 cents less, respectively, the opinion of the witness *43 is based upon a sale of comparable cotton on December 2, 1920. In that case where the opinion places the value 2 cents higher than used in the inventory, the witness based his opinion upon the price at which he could have sold cotton*3626 which had been offered to him by a southern shipper on December 31, 1920. The basis upon which the witness arrived at the value which is 5 cents in excess of that used by the petitioner does not appear. In three instances the testimony offered was that of a witness who was without sufficient familiarity with the cotton to express an opinion which is entitled to any weight and in three other instances no testimony of the value was offered.
There is testimony by both the brokers and the general manager of the petitioner to the effect that at the close of 1920 the market for raw cotton was in a somewhat unsettled condition, the price of cotton having suffered a very serious decline during that year, commencing in the month of May. One of the brokers stated in substance that while the market price could be fixed within fairly definite limitations, various brokers would probably disagree as to the exact price; that their differences might reasonably amount to as much as one cent a pound in the better grades of cotton such as those used by the petitioner. In view of this testimony it is interesting to note that in only six instances did the price fixed by the opinion evidence vary*3627 more than one cent a pound from the price used by the petitioner in its inventory and accepted by the Commissioner. In two of those six cases the opinion of the witness was higher than that used by the petitioner. In the other four it was lower. In two of the four cases in which it was lower the opinion was based upon sales of comparable cotton made practically one month prior to the date when the inventory was prepared. It thus appears that in practically every instance where the opinion expressed by a witness is based upon satisfactory evidence of market value, the price placed by the petitioner upon its cotton falls within the limits of the difference in value indicated as reasonable by the testimony.
This inventory was priced at the time to which it relates by one who was familiar with the cotton which he was pricing and who was in a position to compare the respective values of similar cotton offered by different brokers under different marks. It bears internal evidence that the witness was in fairly close touch with the domestic market. Considering all of these factors it is our opinion that the inventory of domestic cotton as originally taken by the petitioner was more*3628 nearly correct than any which could now be arrived at on the basis of the testimony offered and that it should not be disturbed.
The situation with respect to the foreign cotton included in petitioner's raw cotton inventory is somewhat different from that of the *44 domestic cotton. The only witness who testified with respect to the cotton described as "sak" placed a value of 32 cents per pound, based upon a sale which took place on February 7, 1921. The evidence before us indicates that while cotton prices advanced somewhat in January, 1921, they suffered further declines in the latter part of that month and in February and that the price of cotton in February, 1921, was lower than it was in December, 1920. In such circumstances a December 31, 1920, market value equal to the price at which a sale was made some weeks later, seems to us unsatisfactory. The Egyptian and Peruvian cotton included in the inventory is valued by the witness at one cent less per pound than that fixed by the petitioner. The market for such cotton appears to have been very inactive and the difference between the value used by petitioner and that expressed by the witness falls within the realm*3629 in which differences in opinion seem reasonable. The greatest difference arises with respect to other values. The petitioner fixed a value of 19 cents per pound for its Mexican cotton while the witness fixed a value of 15 cents per pound. The witness testified that there had been no sales of such cotton to his knowledge since early in the year. He further testified that he had no knowledge of the type of such cotton purchased by the petitioner. The same witness testified that the same would be true with respect to the Haitian cotton which was inventoried by the petitioner at 21 cents per pound and upon which the witness placed a value of 13 3/4 cents per pound, stating that such value was arrived at by comparing Haitian cotton with Egyptian cotton, although at the same time stating that he had no knowledge of the type of Haitian cotton purchased by the petitioner. This witness expressed no opinion with respect to the value of San Domingo cotton but the general manager testified that it was substantially the same grade as Haitian and now values that cotton at 13 3/4 cents per pound.
The petitioner's general manager was thoroughly familiar with cotton and its various grades. *3630 The inventory made by him groups the Haitian, Peruvian, and San Domingen cottons under the grade of "Eg.," apparently indicating that in grade it was the equivalent of the Egyptian cotton and in the inventory it is priced the same as Egyptian cotton. On the other hand, the witness who was called upon to express an opinion of their value testified that he did not know the grade of such cotton which the petitioner had on hand but was testifying from his knowledge of the kind of cottons usually received from those countries. Considering the qualifications of the general manager, it seems reasonable to conclude that these foreign *45 cottons were equivalent in grade to the Egyptian cotton and should be valued as such. His conclusions in respect to such cottons seem to us to be entitled to more weight than those of the witness. After a careful consideration of the testimony with respect to such foreign cottons we feel that the values fixed by the petitioner in its inventory more nearly represent the true market values than those for which petitioner now contends.
Coming then to a consideration of the domestic and foreign waste, we find the opinion testimony to be no more*3631 than a guess. The witness had made no sales or purchases which might be used as a basis for fixing value and testified that there was no market; that any price was too high. He places values of 8 and 9 cents a pound on the waste. The nearest transaction of which he had knowledge was a purchase by him of similar waste at 8 1/4 cents per pound on May 27, 1921. Cotton prices were lower at that time than at the end of December, 1920. The witness sold this particular purchase at that time at a profit.
This testimony impresses us as being no more than a guess as to market value. The witness was without any basis to determine a market at that date. In the absence of any market, intrinsic value is frequently used. The general manager of the petitioner was as well qualified, if not better, than was this witness, to judge the intrinsic value of the waste. He could compare its value to petitioner with the value of other cottons and arrive at a conclusion which should be acceptable in the absence of any satisfactory proof of a market value. We are satisfied that the evidence does not justify us in disturbing the values used by petitioner in its inventory of waste.
The second issue*3632 presented by the parties is the valuation of petitioner's inventory of goods in process and finished goods on December 31, 1920. The Revenue Act of 1918, in section 203, provides that whenever inventories are necessary they shall be taken upon such basis as the Commissioner, with the approval of the Secretary, may prescribe. Pursuant to such authority the Commissioner, with the approval of the Secretary, promulgated regulations to the effect that inventories should be valued at either (a) cost, or (b) cost or market whichever is lower, such basis to be applied with reasonable consistency to the entire inventory. Such regulations, as amended by Treasury Decision 3296, contained an exception in the case of goods which were the subject of firm sales contracts. This regulation as amended provides:
Under ordinary circumstances, and for normal goods in an inventory, "market" means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which ordinarily purchased by *46 the taxpayer, and is applicable in the cases (a) of goods purchased and on hand, and (b) of basic elements of cost (materials, labor, and burden) in*3633 goods in process of manufacture and in finished goods on hand; exclusive, however, of goods on hand or in process for delivery on firm sales contracts (i.e., those not legally subject to cancellation by either party) at fixed prices entered into before the date of the inventory, which goods must be inventoried at cost.
The parties are in agreement as to the method upon which the cost or market value of the inventory is to be computed. They are at odds as to what portion of the inventory of finished goods or goods in process is to be taken at cost, because covered by firm sales contracts, and what portion is to be taken at market. They also differ as to whether in computing the inventory at market, effect should be given to a reduction in wages which took place shortly prior to December 31, 1920. Upon the latter question we entertain no doubt that in arriving at the market value of such goods the item of labor should go into the computation at the prices prevailing at the close of the year. We see no difference between this and any other item entering into the computation.
It was customary for the petitioner to take orders in advance for a specified number of pounds of yarn*3634 to be delivered as specified in the contract. The pertinent part of a typical contract reads as follows:
Quantity 50,000 Lbs.
Count 18's, 32's, 36's, 38's, 40's, 45's, 50's, 55's, 60's, in 2, 3, or 4 ply.
Description: Combed Sak. Yarn. Reverse thread skeins.
Prices Below:
Shipments 2000 Lbs. weekly beginning early April 1920.
NOTE: - Customer not to specify less than 2000 Lbs. of a count at any one time. Shipping Directions to be forwarded later.
| PRICES: | 18/1 | $ 1.32 |
| 18/2 | 1.42 | |
| 32/3 | 1.59 | |
| 36/3 | $1.67 | |
| 38/3 | 1.71 | |
| 40/3 | 1.76 | |
| 45/3 | $1.89 | |
| 50/3 | 1.96 | |
| 55/3 | 2.08 | |
| 60/3 | 2.21 |
Under this form of blanket contract the purchaser had the option of purchasing any of the yarns specified at the prices stated and in advance of such specifications it was impossible for the petitioner to set aside any particular yarn for such order. It was customary for the petitioner, however, to manufacture yarns in advance of receiving specifications and to place such yarns in stock. These yarns might later be used to fill such blanket orders or might be used in fillings orders subsequently received or in making immediate delivery of new purchases.
*3635 On December 31, 1920, the petitioner had on hand 522,812 pounds of goods either in process or finished. At the same date it had on hand unfilled blanket orders for 230,376 pounds of yarn. Of this *47 quantity, 103,023 pounds were covered by specifications received prior to January 1, 1921. On the balance of the orders the petitioner had not received any specifications and it was impossible for it to determine what yarns would be required under the balance of such contracts.
In determining the deficiency the Commissioner valued all of the inventory of goods in process and finished goods at cost on the theory that they were covered by firm sales contracts. This is now admitted by the respondent to be error. His counsel now contends that 230,376 pounds of this inventory should be valued at cost because covered by firm sales contracts. Petitioner concedes that 103,023 pounds were covered by firm sales contracts and should be valued at cost. The difference between the parties is with respect to 127,353 pounds, being the amount covered by contracts on which the petitioner had not yet received specifications.
The evidence establishes that prior to the receipt of specifications*3636 it was impossible to determine what size and quantities of yarn would be required for unfilled portions of the contracts and that neither the goods in process nor finished goods could be allocated to any particular order until specifications were received. Prior to the receipt of specification petitioner could not know whether any of the goods which were manufactured or in process of manufacture would be the particular kind of yarn which would be specified for delivery on the outstanding orders. Under this state of facts it seems clear that only that portion of the inventory which was covered by contracts on which specifications had been received on December 31, 1920, can be said to be on hand for delivery on firm sales contracts. These yarns came within the exception laid down in Commissioner's regulations to the general rule that inventories are to be taken upon the basis of cost or cost or market whichever is lower. Those goods which were finished or in process of manufacture, which might or might not be assigned later to any existing contract, and which were available for any orders which might be received, did not fall within the exception but fall within the general rule*3637 and should be valued at market, which was lower than cost. We are therefore of the opinion that 103,023 pounds of finished yarn in the inventory should be valued at cost and the balance of the finished yarns and the yarns in process should be valued at market.
All of the factors on which the petitioner's inventory of finished goods and goods in process may be computed upon the basis indicated, are in the record. The method to be followed is not in dispute. The proper computations should be made by the parties and submitted by them at or prior to the date of recomputation of the deficiency under Rule 50. At the same time the parties may file *48 requests for additional findings of fact upon this issue, which shall embody the result of such computations, setting out the market value of so much of this portion of petitioner's inventory as is based upon market values and the cost of so much of petitioner's inventory as is based upon cost.
There is much evidence in the record with respect to depreciation, all of which has been considered. Petitioner claims a normal rate of depreciation of 5.96 per cent of cost of machinery for normal day time operation and asks that this*3638 be increased proportionately for overtime operation of the plant. It must be recognized that there is no method by which depreciation may be computed to the ultimate penny. All we can hope is to arrive at a fairly accurate allowance in the light of all the circumstances. Here we believe that an allowance in each of the years of 7 per cent of cost is proper.
Decision will be entered under Rule 50.