*2907 1. Deduction by respondent of $9,600 from petitioner's inventory as of January 1, 1920, disapproved.
2. Inclusion by respondent of $1,010.57 in petitioner's income for January, 1920, disapproved.
3. Deduction of an alleged bad debt of $4,361.57 disallowed.
*778 This proceeding is brought to redetermine the income and excessprofits taxes of the Piedmont Lumber Co. in the sums of $4,889.98 and $1,776.57 for the years 1920 and 1921, respectively.
The petitioner alleges the following errors: (1) The reduction of $9,600 in the inventory as of January 1, 1920; (2) inclusion of the sum of $1,010.57 in income for January, 1920; and (3) the disallowance of a bad debt amounting to $4,361.57.
FINDINGS OF FACT.
The petitioner is a corporation organized in September, 1919, under the laws of the State of South Carolina, with its principal office at Greenville.
Prior to 1920 the books of the petitioner had been kept on a single entry basis. On January 2, 1920, the directors of the petitioner ordered its accounts for 1919 to be audited and directed*2908 that a proper system of accounting be installed. The petitioner thereupon employed an auditor named Dawes to perform that work. Dawes opened a system of double entry bookkeeping as of January 1, 1920. Certain opening entries, however, including those of inventory and surplus, appear under date of February 1, 1920, about the time Dawes took possession of the original single entry books of the petitioner and began his work. Sometime after opening the petitioner's books and making his auditor's report thereon, Dawes died and the original books of the petitioner could not be found. The inventory was taken at cost by the secretary of the petitioner at December 31, 1919, and the amount thereof was computed to be $27,528.41. This amount appears in the profit and loss account as the inventory of January 1, 1920, but the same amount also appears on the inventory account under the date of February 1, 1920. The latter date is shown to be in error, arising from the fact that Dawes opened the new set of books for the petitioner approximately on February 1, 1920.
*779 In the petitioner's surplus account appears an item of $2,021.14 as of February 1, 1920. This is the same amount*2909 appearing as income for the year 1919 on which petitioner paid a proper tax. It was carried over as surplus on January 1, 1920, and erroneously entered under date of February 1, 1920. The respondent added one-half of th surplus, or $1,010.57, to the petitioner's income for January, 1920.
During 1920 the petitioner sold to J. L. Vass building materials amounting to $5,361.57, of which he paid $1,000, leaving a balance of $4,361.57. The last entry on this account was made on June 11, 1920, with the exception of a small repair item of $2.50 purchased in November, 1920. During 1921 the petitioner investigated the financial standing of Vass, discovered that there was a mortgage against his property approximately equal to its then value, that Vass was practically bankrupt, and determined to charge the account off as a bad debt. Later, during the year, the holder of the first mortgage threatened to foreclose, and by agreement Vass conveyed the property to the petitioner. On October 21, 1921, the petitioner paid the interest on the first mortgage then due and on the next day discharged the mortgage indebtedness entirely. In December, 1921, when the petitioner closed its books, the*2910 amount due from Vass - $4,361.57 - was charged off to profit and loss as a bad debt. The house was sold in 1923 at a profit of approximately $1,000, on which the petitioner paid its income tax. This sum was credited to profit and loss in that year.
OPINION.
VAN FOSSAN: It is clearly established that the amount of petitioner's inventory on December 31, 1919, was $27,528.41. The closing inventory of one year is the opening inventory of the next. . Consequently, this sum is the correct inventory figure for January 1, 1920. It was so considered and treated by the petitioner on its books and constituted the basis of its income-tax return for 1920. The inventory account contains the erroneous date of February 1, 1920, due to the fact that a new set of books was opened for the petitioner on or about that date. Entries in the merchandise inventory account were made yearly. We are convinced that the sum named is a proper inventory figure for January 1, 1920, and that any deduction therefrom is unwarranted. Therefore, we disapprove the respondent's action in reducing the opening inventory by $9,600.
The respondent added*2911 to the petitioner's income for January, 1920, the sum of $1,010.57, on the theory that its return for that *780 year was made on the basis of 11 months. The petitioner's balance sheet of February 1, 1920, showed earnings or surplus of $2,021.14, which the respondent arbitrarily assumed represented the earnings of the petitioner during the year 1919 and the month of January, 1920, and prorated them equally to those periods. The evidence discloses that the said sum of $2,021.14 was the income of the petitioner for the year 1919, properly returned by it as such and treated as surplus as of January 1, 1920, in Schedule K of its return for the year 1920. The erroneous entry of this item under date of February 1, 1920, was occasioned by the circumstances mentioned above. Therefore, we conclude that the sum of $1,010.57 did not constitute income for January, 1920, and the respondent's action in so treating it was erroneous.
As to the alleged bad debt we are unable to find that respondent erred. When issue is joined as to the allowability of a deduction of an alleged bad debt the burden is on the petitioner to prove both the fact of worthlessness and the charge-off during the*2912 year. ; ; . Here some time during the year petitioner determined the account to be worthless but took to no steps looking to a charge-off at that time. Later in the year, by agreement with the debtor, petitioner took over the property of the debtor and paid off the mortgage thereon. This action was apprently motivated by the thought that, property then being at low market, by securing the title to the property petitioner would be able later to work out its account in whole or in part. After thus taking title to the property petitioner nevertheless charged off the entire debt as worthless at the close of the taxable year.
We are not persuaded that this purchase of the property by petitioner was, as contended by it, a wholly independent venture totally disassociated with the existence of the alleged bad debt. It appears more in the nature of an undertaking to assure and secure the payment of the debt. In such a situation we are unable to agree with petitioner's contention that at the time of the charge-off the*2913 debt had been properly ascertained to be worthless or that it was in fact worthless. We affirm the respondent on this point.
Judgment will be entered under Rule 50.