*135 Decisions will be entered under Rule 50.
A partnership, which computed its income on the completed contract basis, made certain accruals upon the completion in 1938 of a contract with the Government. The accruals included $ 28,200 which in 1939 the Government refused to pay, and in order to collect the partnership brought suit in the Court of Claims. In 1946 the partnership recovered a net judgment in the amount of $ 12,915.66. To the extent of $ 2,500, the judgment represented the balance due on the contract price which the Government conceded was due. The balance of the recovery represented damages for delays caused by the Government less the amount of certain disputed bills. Held, the amount of the judgment in excess of $ 2,500 was includible in the 1946 taxable income of the partnership. Held, further, the partnership was not entitled to deduct the difference between the amount accrued in 1938 which the Government refused to pay and the amount of the judgment rendered in 1946.
*723 For the taxable year*136 1946 the Commissioner determined deficiencies in the income tax of the petitioner A. D. Irwin in the amount of $ 7,103.70 and in the income tax of the petitioners A. O. Leighton and Gertrude Leighton in the amount of $ 3,860.23. The proceedings were consolidated for hearing. The issues for decision are:
1. Whether the Commissioner erred in including in partnership income for the year 1946 a recovery in the Court of Claims in the amount of $ 12,915.66.
2. Whether the Commissioner erred in denying the deduction of the difference between a $ 28,200 accrual made in 1938 and the $ 12,915.66 judgment which represented the net recovery on the items accrued.
An additional issue respecting medical expenses disallowed by the Commissioner in the case of the petitioner A. D. Irwin is dependent upon the determination of the principal issues and any adjustment made necessary thereby may be made in a Rule 50 computation.
FINDINGS OF FACT.
The stipulated facts are so found.
The petitioners are residents of Philadelphia, Pennsylvania, and filed their income tax returns for the year 1946 with the collector of internal revenue for the first district of Pennsylvania. The petitioners A. O. Leighton*137 and Gertrude Leighton are husband and wife. The petitioners A. D. Irwin and A. O. Leighton are partners engaged in the building construction business under the firm name of Irwin and Leighton (hereinafter referred to as the partnership).
On December 5, 1936, the partnership entered into a contract with the United States, represented by Oscar L. Chapman, Assistant Secretary of the Department of the Interior, as contracting officer, under which the partnership agreed, in consideration of the sum of $ 817,225, to construct a library building at Howard University in Washington, D. C., in accordance with drawings and specifications made a part of such contract.
*724 The contract provided that work was to commence within 10 days after receipt of notice and was to be completed within 325 days from that date. The partnership received notice on December 21, 1936. Work was to be completed by November 11, 1937.
During the performance of the work certain time was lost because of weather conditions and strikes for which the partnership was not responsible. Additional time was also required for added work ordered by the contracting officer. In addition certain delays were incurred which*138 the partnership contended were due to action or nonaction on the part of the Government, such as delay by the Government architect in approving plans, delay of Howard University officials in making the old building available for demolition, and a strike caused by Howard University using nonunion employees near the site of the library construction.
In conformity with the terms of the contract, in each instance of delay, the partnership gave to the contracting officer the required notice, complained of the delay, and made application for extensions of time. As provided by the contract, said contracting officer investigated the facts concerning said delays and issued change orders granting extensions of time. The extensions relieved the partnership from liability for liquidated damages for failing to complete the contract within the time specified. Change orders totaling 230 days, including Saturdays, Sundays, and holidays, were issued by the Government contracting officer with reference to delays which the partnership contended were incurred due to action or nonaction on the part of the Government, as follows:
| Change | Extension | |
| Order No. | Letter dated | granted (days) |
| 1 | January 25, 1937 | 5 |
| 2 | March 9, 1937 | 7 |
| 3 | April 21, 1937 | 13 |
| 21 | July 14, 1938 | 25 |
| 26 | October 21, 1938 | 150 |
| 30 | March 10, 1939 | 30 |
| 230 |
*139 Change Orders No. 1, No. 21, and No. 26 all contain a provision which states there is no change in the net contract price because of the extension of time therein granted. In Change Order No. 30 the partnership was granted the full number of days requested.
In connection with the application for and the receipt of the above-enumerated change orders, certain correspondence took place between the partnership and the office of the Secretary of the Interior in which the partnership informed the Secretary of the Interior that additional expenses were being incurred as the result of delays for which the Government was responsible and that reimbursement for these expenses *725 would be claimed. The office of the Secretary of the Interior acknowledged the receipt of the partnership's letters.
In a letter to the partnership dated April 14, 1938, concerning Change Order No. 21, Oscar Chapman, Assistant Secretary of the Interior, stated:
Reference is made to your letter of March 24, advising that upon termination of the strike existing at Howard University you will request an extension of your contract time as well as a claim for reimbursement of certain expenses incurred therewith.
Upon*140 receipt of definite information from you the Department gill give consideration to this matter.
In a letter to the partnership dated May 14, 1937, concerning Change Order No. 26, T. A. Walters, First Assistant Secretary of the Department of the Interior, stated:
This will acknowledge your letter of May 5 notifying the Department of the delay and additional expense being caused you, in connection with your contract for the construction of the Library Building at Howard University, by not receiving approved mechanical shop drawings, etc., which are being held up on account of the expectancy of restoring Alternate No. 35.
As soon as a definite decision has been made concerning Alternate No. 35, the air-conditioning installation, the Department will request you to submit an itemized claim showing the extent of the delay and additional expense.
Work on the Howard University contract was substantially completed on November 28, 1938, and the Government accepted the keys to the building and took possession thereof.
A letter of appreciation for the successful manner in which the contract was completed was written to the partnership by the Government architect on December 20, 1938.
The partnership*141 had experience with a number of other Government contracts, but it had never had any experience with claims for reimbursement due to delays allegedly caused by the Government. At the end of 1938 the partnership estimated that its claim for reimbursement because of these delays amounted to approximately $ 25,700. The estimate was based upon calculations by a bookkeeper under the supervision of the partnership's office manager who ordered the accrual of the amount of the estimate on the advice of a certified public accountant. It was estimated that the partnership was entitled to reimbursement for 257 days at the rate of $ 100 per day. The $ 100 per day consisted of $ 39.02 for field office personnel; $ 53.97 for central office overhead; and the balance for Federal taxes, unemployment insurance, other insurance, heat, and utilities.
On December 29, 1938, when all but $ 46,949.87 of the total contract price had been paid, the partnership prepared its voucher for payment of the balance of the contract price. The voucher showed a deduction of $ 2,500 from the total amount due, with the following explanation:
*726 less amt. retained until bal. of elec. fixtures are selected *142 and subsequent inspection.
Attached to the voucher was a detailed estimate of the work done for the period ending December 29, 1938, upon which the following was endorsed:
The sum $ 2,500 is withheld for the furnishing and installation of 14 electric brackets at the fireplaces and a few very minor items revealed in the final checkup. These are special fixtures; they are to be installed upon the completion of the architect's full size drawings, renderings, and the subsequent manufacture.
The installation of the electric brackets was to be performed by the partnership's electrical subcontractor.
The partnership computes its distributable income on a completed contract basis. Such method of accounting contemplates proper accrual of all unpaid billings and accounts receivable at the time the contract is completed.
The partnership reported a profit on the Howard University contract of $ 60,318.01 in 1938. This profit was calculated in part on the basis of accruals, as of the end of 1938, of $ 75,000 of accounts payable and $ 72,649.87 of alleged accounts receivable.
The accounts receivable accrual of $ 72,649.87 consisted of $ 46,949.87, the sum then due under the basic contract, *143 including the $ 2,500 upon which payment was to be deferred, plus $ 25,700 which represented the amount of the partnership's estimated claim for additional expenses incurred as the result of the delays aforementioned.
On February 24, 1939, the Government paid the partnership $ 44,449.87, leaving a balance due under the contract of $ 2,500. In June or July 1939, the partnership employed a Washington attorney to prepare its claim arising out of the delays and to negotiate with the Government for a settlement. Failing to reach a settlement, a suit for $ 40,673.29 was brought in the Court of Claims of the United States in 1940, claiming damages for delays considerably in excess of the original $ 25,700 estimate. The petition in that action also requested payment of the $ 2,500 unpaid balance due on the contract for which the partnership had submitted its voucher on August 12, 1939. The $ 2,500 had been withheld because the partnership refused to pay both a $ 704.08 heat and electricity bill which Howard University had sent to the partnership on June 5, 1939, and a bill for a bulletin board in the amount of $ 36.93. The partnership also presented certain claims on behalf of its subcontractors.
*144 On March 4, 1946, the Court of Claims entered its decision awarding the partnership $ 12,915.66. . Included in the $ 12,915.66 judgment was the $ 2,500 balance due on the contract. The Government had always *727 conceded that the partnership was entitled to the $ 2,500 and had retained said sum solely because the partnership refused to pay the above-described bills in the aggregate amount of $ 741.01. The balance of the judgment represented damages for delays caused by the Government less the amount of the above bills aggregating $ 741.01. In holding the Government liable for damages, the Court of Claims found that the Government had delayed the work of the partnership a total of 129 days which resulted in increased field costs of $ 33.41 per day or a total of $ 4,309.89 and increased general overhead of $ 42.22 per day or a total of $ 5,446.38. The Court of Claims also found that as a result of the delays the partnership was forced to furnish heat from January 27 to April 27, 1938, at a cost of $ 1,400.40 for which the partnership was also entitled to recover. *145 Prior to the decision of the Court of Claims the extent of the Government's liability for damages was not fixed and the amount of the liability could not reasonably be estimated.
The $ 12,915.66 award was not reported as income by the partnership in 1946.
The partnership charged off as a business bad debt in 1946 the sum of $ 15,284.34, being the difference between the amount of the award and the $ 28,200 accrual in 1938.
The Commissioner disallowed the bad debt charge-off and included in income in 1946 the amount of the award, $ 12,915.66.
OPINION.
The entire controversy turns upon whether the partnership, comprised of two of the petitioners, properly accrued as income in 1938 certain claims against the Government arising out of the partnership's contract to build a library at Howard University. The library building had been substantially completed in 1938 and the Government had been billed for all but $ 2,500 of the contract price. At the end of that year the partnership accrued the $ 2,500 together with $ 25,700 which it estimated was the amount of its claim for damages as a result of delays in the work which it contended were caused by the Government. Petitioners' contention*146 that these accruals were proper is controverted by the respondent.
The partnership computes its income on the completed contract basis. 1 Such method of accounting contemplates proper accrual of *728 all unpaid billings, accounts receivable, and accounts payable in the year the contract is substantially completed, which in the instant case was 1938. V. ; . The only exception to the rule requiring the accrual of outstanding items in the year of completion is made in the case of outstanding items which are "contingent and uncertain." , affd. (C. A. 8) ; , affd. (C. A. 5) . We must therefore determine whether the items in question came within this exception.
*147 In his brief the respondent does not mention the $ 2,500 balance due on the contract price which was accrued in 1938 and recovered as part of the judgment in 1946. We, therefore, are unaware of the respondent's reasons for determining that the $ 2,500 was not properly accruable until 1946. At no time did the Government contest the partnership's rights to the $ 2,500. At the end of 1938 there was no reasonable uncertainty with regard to its ultimate payment; and in our opinion the item was properly accrued in 1938. Cf. When the partnership disputed and refused to pay two bills aggregating $ 741.01 with which it was presented in 1939, the Government withheld the $ 2,500 with the idea of effecting a set-off. The possibility of a set-off, however, did not affect the propriety of the accrual of the partnership's undisputed claim to the $ 2,500. .
Whether the partnership's estimated claim for damages in the amount of $ 25,700 was sufficiently fixed at the end of 1938 to warrant its accrual is the principal matter in dispute. It was well settled that the partnership*148 as a contractor was entitled to recover as damages the amount of its expenses incurred by reason of delays caused by the Government. . Here there had been a number of delays due to no fault of the partnership. The partnership was of the opinion that six of those delays were caused by the Government, and at the end of 1938 there was nothing to indicate that there would be any controversy as to the Government's liability with respect to those delays. However the partnership had never billed the Government or made a precise claim for the $ 25,700 up to the end of 1938, and the amount then accrued by *729 the partnership was a mere estimate on its part. While the partnership had good reason to believe that the Government was liable for some of the six delays, the amount of the liability was by no means certain. The number of days lost due to delays caused by the Government could only be estimated. At the end of 1938 the partnership had been granted extensions totaling 200 days by reason of delays for which it considered the Government liable, but in computing its proposed claim the partnership*149 had used 257 days. Also in doubt was the amount of the partnership's damages for each day lost. For example, over one-half of the $ 25,700 accrual consisted of a pro rata portion of partnership's central office overhead. At the end of 1938 there was no legal precedent for including central office overhead in computing a contractor's damages. The first case allowing a pro rata portion of a contractor's central office overhead in computing his damages appears to have been , which was decided June 5, 1944, 5 1/2 years after the accrual here in question.
Unlike the cases cited by petitioners, the amount of the liability was extremely uncertain and could neither be reasonably estimated nor ascertained by a mere computation. The accrual in 1938 in the amount of $ 25,700 was therefore improper. ; ; . The amount of the 1946 judgment in excess*150 of $ 2,500, or the damages for delays less the amount of the disputed bills ($ 10,415.66), was includible in the partnership's 1946 taxable income and the claimed bad debt loss was properly disallowed.
Decisions will be entered under Rule 50.
Footnotes
1. Regs. 101. Chapter VII. Accounting Periods and Methods.
Part IV -- Accounting Periods and Methods of Accounting.
ART. 42-4. Long-term contracts. -- Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used in this article the term "long-term contracts" means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon either of the following bases:
* * * *
(b) Gross income may be reported for the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of completion.↩