*3550 1. An issue argued in the brief, but not raised in the pleadings, is disregarded.
2. Obsolescence of machinery set aside in 1918 and finally discarded in 1920 allowed in 1920.
3. Proper basis as well as rate of depreciation determined.
*383 This proceeding is to redetermine a deficiency against the Keewis Realty Co., Inc., for 1920, of $1,602.55, and one against the Great Bear Spring Co. for 1921, of $6,641.16. The notice of deficiency also states an overassessment of the Great Bear Spring Co. for 1920, of $2,890.13.
The petitioners admittedly are affiliated and filed consolidated returns for these years. They allege errors on the part of the Commissioner in substance as follows: (1) failure to compute taxable income on accrual basis; (2) failure to compute invested capital consistently with the accrual basis; (3) failure to allow proper depreciation.
FINDINGS OF FACT.
The Great Bear Spring Co. (hereinafter called the Spring Company) is a New Jersey corporation, and the Keewis Realty Co. (hereinafter called the Realty Company) is a New*3551 York corporation. Each has its principal office in New York City. The Spring Company is in the business of bottling and selling natural spring water, which it delivers at offices and homes. The Realty Company holds title to real estate which is leased to the Spring Company. The Spring Company has branches at Jersey City, Philadelphia, Albany, Harlem (New York), and Buffalo, from which it delivers water.
Consolidated income-tax returns were filed for 1920 and 1921 and the Commissioner acquiesced in their claim of affiliation.
The balance sheet of the Spring Company as of December 31, 1919, is as follows:
| Assets | Value | Liabilities | Value |
| Plant account | $31,986.41 | Drivers deposit | $524.25 |
| Bottles and crates | 97,565.16 | Capital stock | 75,000.00 |
| Stable account | 20,654.25 | Federal income tax reserve | 7,329.37 |
| Spring account | 17,500.00 | Accident insurance reserve | 4,968.35 |
| Cars | 24,500.00 | Surplus | 172,484.40 |
| Farm account | 6,520.75 | ||
| Cash | 56,210.05 | ||
| Petty cash | 1,747.00 | ||
| Great Bear Water Works | 3,200.00 | ||
| Willard J. Hall | 422.75 | ||
| Total | 260,306.37 | Total | 260,306.37 |
*384 The surplus appearing above does not reflect accounts receivable, supplies*3552 and water coolers. On December 31, 1919, it had accounts receivable as follows:
| Jersey City | $22,097.86 |
| Philadelphia | 5,613.02 |
| Albany | 1,690.98 |
| Harlem | 10,046.03 |
| Buffalo | 5,751.11 |
| Total | 45,199.00 |
It had supplies on hand which had cost $3,300.82 and had been charged to expenses. The supplies consisted of corks, stationery, stable supplies, labels, etc. It was the Spring Company's practice to charge the cost of coolers to expenses. Their average life was 10 years. Up to December 31, 1919, it had thus expended for coolers $98,643.31. The depreciation amounted to $47,791.95, leaving an unexpired book value of $50,851.36. An inventory of coolers on hand December 31, 1919, shows a value of $38,100.
The balance sheet of the Spring Company as of December 31, 1920, is as follows:
| Assets | Value | Liabilities | Value |
| Plant account | $26,122.50 | Drivers' deposits | $504.85 |
| Bottles and crates | 85,331.12 | Capital stock | 75,000.00 |
| Stable account | 24,997.80 | Federal income tax reserve | 7,192.17 |
| Spring account | 15,000.00 | Accident insurance reserve | 6,262.35 |
| Cars | 19,800.00 | Surplus | 151,714.58 |
| Farm account | 7,511.47 | ||
| Cash | 54,093.60 | ||
| Petty cash | 1,847.00 | ||
| Great Bear Water Works | 3,200.00 | ||
| Willard J. Hall | 50.97 | ||
| Owens Bottle Co | 1,919.49 | ||
| Arrowhead Mills | 800.00 | ||
| Total | 240,673.95 | Total | 240,673.95 |
*3553 The surplus appearing in this balance sheet does not reflect accounts receivable, supplies and water coolers. The accounts receivable outstanding at this date were as follows:
| Jersey City | $32,587.71 |
| Albany | 2,019.21 |
| Harlem | 6,444.60 |
| Buffalo | 6,109.35 |
| 47,160.87 | |
| Less Credit balance for tickets outstanding, Philadelphia | 1,795.24 |
| 45,365.63 |
Supplies on hand amounted to $4,496.79. Expenditures for coolers to December 31, 1920, amounted to $105,995.89. Petitioner claims an unexpired value for coolers of $47,972.01, after deducting depreciation *385 of $58,023.88. An inventory of coolers on hand December 31, 1920, shows a value of $38,444.
During 1921, there was expended for coolers $11,146.44.
The accounts of the customers were kept in auxiliary ledgers at the branch offices, which made all collections. Each branch made a daily sales report to the main office which showed the number of packages delivered and their value, and the amount of cash received, the latter item being separated into cash sales and cash received on accounts. In addition to the auxiliary ledgers, the branches kept copies of the cash sheets, the originals of which were*3554 sent to the main office. The latter kept a general ledger, cash book, journal, sales book, inventory book and cash statement book. The same system of recording sales and accounts receivable was in effect prior to 1920 since the corporation was formed in 1899. The accounts receivable were not carried into the general ledger until 1921, but were carried in the inventory book. It has no accounts payable, but pays cash for its purchases as soon as bills are received.
The profit and loss account for 1921 contains, among others, the following entries:
| Jan. 1 - Additional assets not earnings | $86,686.70 |
| Dec. 31 - Difference in inventories | 1,097.26 |
On another page in the ledgers, there appears the following:
| Supplies, coolers, accounts receivable. Dr. | ||||
| Supplies | Coolers | Accounts receivable | Total | |
| 1921 | ||||
| Jan. 1: | ||||
| Inventory | $2,877.07 | $38,444.00 | $45,365.63 | $86,686.70 |
| Profit and loss | 1,097.26 | |||
| Total | 87,783.96 | |||
| 1922 | ||||
| Jan. 1, inventory | 5,501.12 | 39,061.00 | 43,221.84 | 87,783.96 |
The net income of the Spring Company, according to its books, for 1920, is $40,422.35; for 1921, $102,717.22.
The following facts with*3555 respect to the Spring Company were stipulated by counsel:
| Dividends paid - Jan. 20, 1920 | $22,500.00 |
| Feb. 20, 1920 | 1,500.00 |
| Jan. 20, 1921 | 1,500.00 |
| Feb. 20, 1921 | 1,500.00 |
Additions should be made to surplus as follows:
| Dec. 31, 1919, Reserve for Federal taxes | $7,329.37 |
| Reserve for accident insurance | 4,968.35 |
| Dec. 31, 1920, Reserve for Federal taxes | 6,262.35 |
| Reserve for accident insurance | 7,192.17 |
*386 The Realty Company at the beginning each of 1920 and 1921, had outstanding capital stock of $191,250, and its surplus was $3,989.65 and $11,401.46, respectively.
Additions should be made to surplus as follows:
| Dec. 31, 1919, Reserve for Federal tax for 1919 | $719.57 |
| Dec. 31, 1920, Reserve for Federal tax for 1920 | 1,351.31 |
The books of the Realty Company show net income for 1920 of $15,513.12; for 1921, $19,340.75.
Depreciation - Spring Company. - This petitioner deducted depreciation as follows in computing net income for 1920:
| Plant account | $6,232.39 |
| Stable account | 8,970.20 |
| Spring account | 2,500.00 |
| Railroad cars account | 4,700.00 |
| Farm account | 133.75 |
| Total | 22,536.34 |
It is stipulated*3556 by counsel that the following amounts of depreciation for the classes of property named are proper for 1920:
| Spring account | $2,900.00 |
| Railroad cars account | 4,900.00 |
| Farm account | 550.19 |
In the plant account are buildings, machinery, and furniture and fixtures. At the beginning of 1920 the Spring Company owned a building at Jersey City, located on leased land, which had a book value of $9,000, and upon which depreciation of $1,000 was taken in 1920. The building was used as a bottling plant, and contained machinery consisting of tanks, sterilizers, shafting, pulleys and conveyors, having a book value of $6,048.35. The company had acquired springs located at Morsemere, N.J., from which it expected to supply its Jersey City and New York trade. When these springs should be put into use, the Jersey City building and machinery would no longer be required. In 1920 it expected to complete the change in about three years. The Jersey City Plant was abandoned in the summer of 1923, and there was no salvage except three machines for washing bottles, valued at $500, which were removed therefrom.
In 1920 the Spring Company closed its Harlem plant. In doing so, it*3557 abandoned machinery having a book value of $1,891.80 which had become worthless.
In 1918 it closed a plant which it had in Brooklyn, N.Y., containing machinery of a book value of $1,750. It carried this machinery on its books until 1920, when it was given away as worthless.
In computing its net income for 1921, the Spring Company deducted as depreciation the following amounts:
| Plant account | $8,041.27 |
| Stable account | 9,718.89 |
| Spring account | 3,750.00 |
| Railroad cars account | 4,000.00 |
| Farm account | 400.34 |
| Total | 25,910.50 |
*387 Counsel have stipulated that the following amounts of depreciation are proper for the last three named accounts for 1921:
| Spring account | $3,050.00 |
| Railroad cars account | 4,900.00 |
| Farm account | 703.79 |
The following additions to the plant account were made in 1921:
| Machinery | $199.50 |
| Furniture and fixtures | 99.00 |
| Total | 298.50 |
The stable account embraced automobiles, horses, wagons, harness, etc. The book values at the beginning of 1920 and additions during that year were as follows:
| Jan. 1 - Automobiles | $3,000.00 |
| Additions during year | 11,899.75 |
| Horses, wagons, etc | 17,654.25 |
| Additions during year | 826.14 |
*3558 The additions to the stable account during 1921 were:
| Automobiles | $5,950.59 |
| Net reduction in horses, wagons, harness, etc | 373.51 |
| Net additions to stable account | 5,577.08 |
The springs which petitioner acquired at Morsemere were located about ten miles from Jersey City and downtown New York. It also acquired springs at Shawmont, Pa., about ten miles from the heart of Philadelphia, from which it intended to supply its customers in the latter city. The previous hauls had been about one and one-half miles. When these springs should be used as the source of supply, it would be necessary to dispense with the use of horse and wagon as the mode of transportation and use automobiles, as the distance was too great for horses to make two round trips daily. In 1920 it was anticipated that the change would be made in three years, and the horses and wagons were in fact displaced by automobiles in that period of time.
The automobiles had a life in service of four years.
The coolers on hand March 1, 1913, and the subsequent additions thereto are given in the following table, together with the amounts of depreciation petitioner claims has accrued:
| Balance and additions | Depreciation | Total accrued | |
| depreciation | |||
| Mar. 1, 1913, balance | $31,928.00 | ||
| 1913 | 11,274.92 | $3,224.41 | |
| 1914 | 11,000.38 | 4,870.30 | |
| 1915 | 9,270.05 | 5,883.79 | |
| 1916 | 9,890.07 | 6,841.79 | |
| 1917 | 13,685.32 | 8,020.57 | |
| 1918 | 9,617.09 | 9,185.68 | |
| 1919 | 1,977.48 | 9,765.41 | 1 $47,791.95 |
| 1920 | 7,352.58 | 10,231.93 | 2 58,023.88 |
| 1921 | 10,937.71 | 11,146.44 | |
| Total | 116,933.60 | 69,170.32 |
*388 Coolers had an average life of 10 years.
Depreciation - Realty Company. - The Realty Company took over the real estate of the Spring Company on March 1, 1918, and gave in exchange therefor its capital stock of $225,000 par value. The property thus acquired consisted of land and buildings having a book value to the Spring Company as follows:
| Jersey City (lot) | $1,200.00 |
| Farm buildings | 26,000.00 |
| South Granby, house and lot | 1,300.00 |
| Brooklyn | 60,000.00 |
| Harlem | 20,000.00 |
| Philadelphia | 56,500.00 |
| Washington | 21,000.00 |
| Buffalo | 24,000.00 |
| Boston | 14,331.23 |
| Total | 224,331.23 |
In 1918, the Boston property and the Washington property were sold for $17,250 and $30,000, respectively, a total of $47,250. Thereafter, in the same year, a liquidating dividend of 15 per cent (or $33,750) was paid, and the amount of the outstanding capital stock was reduced accordingly.
The buildings on the several parcels of land (excluding Boston and Washington) were as follows:
Farm. - Farm buildings of wood construction.
South Granby. - Two-story dwelling, of wood.
Buffalo. - Building of wood and*3560 brick, especially constructed as a bottling plant with tanks built in the second floor; and with a stable and wagon sheds.
Brooklyn. - Three-story building of brick and concrete, without cellar, constructed as a bottling plant, with a small boiler room, stable and wagon shed; beams were of concrete filled in with brick.
Philadelphia. - Building of brick and wood constructed as a bottling plant and loft building, with a tank built in the second floor; with stable and wagon shed, and a railroad siding. Location, corner of 31st and Chestnut Streets.
Harlem. - Brick and wood building used as a horse stable.
The following tabulation shows the cost of the buildings to March 1, 1913, the value on the books of the Spring Company at the time of *389 the transfer, the years in which they were severally built, the estimate life, and unexpired life on March 1, 1918.
| Location | Year built | Estimated | Unexpired | Cost to Mar. | Book value |
| life | life | 1, 1913 | Mar 1, 1918 | ||
| Years | Years | ||||
| Farm | 1893 (acquired, 1900) | 40 | 15 | $14,476.66 | $12,471.26 |
| South Granby | 1905 | 20 | 7 | 3,048.52 | 1,056.76 |
| Buffalo | 1898 (rebuilt, 1904) | 40 | 20 | 30,804.09 | 19,000.00 |
| Brooklyn | 1906 | 40 | 28 | 75,207.52 | 47,175.00 |
| Philadelphia | 1906 | 40 | 28 | 52,703.24 | 33,000.00 |
| Harlem | 1893 (acquired, 1907) | 40 | 15 | 18,005.08 | 3,396.98 |
| Total | 194,245.11 | 116,100.00 |
*3561 The cost to March 1, 1913, is the total cost without any deduction for depreciation. The difference between such cost and the book value March 1, 1918, represents depreciation in the intervening years. There were no additions or betterments in this period.
OPINION.
LOVE: Before discussing the issues, we will dispose of two claims made by petitioners in their brief.
The first is, that another company, viz, the Great Bear Water Works Co., was affiliated with them. Testimony intended to prove the fact was offered by petitioners during the taking of a deposition and was duly objected to on behalf of the respondent. There are no allegations in the pleadings relating to it and we are, therefore, precluded from considering this claim.
Second, the petitioners invoke the jurisdiction of the Board to redetermine the tax of the Spring Company for 1920. It is asserted in the brief that the amount of overassessment of this company, mentioned in the deficiency letter, is the disallowed portion of a larger amount as to which a claim in abatement had been filed. However, the facts are not pleaded and are not in evidence and there is, therefore, nothing before us upon which we may*3562 act. The only reference to an abatement claim is a sentence in the deficiency letter, reading, "Consideration has been given the statements contained in your claim for the abatement of $3,648.60, 1920 income and profits tax." On its face, the deficiency letter states merely an overassessment of the Spring Company for 1920. This is the only fact before us, and we have no jurisdiction to redetermine an overassessment.
The consolidated tax assessed against the two petitioners was apportioned by the Commissioner between them on the basis of the income assignable to each. Section 240, Revenue Act of 1918. In redetermining the deficiency of the Realty Company for 1920 and of the Spring Company for 1921, it is necessary to consider any evidence *390 affecting the consolidated tax, but we have no jurisdiction to redetermine the tax liability of the member of the affiliation against which no deficiency has been determined.
It is alleged that the petitioners were on the accrual basis of accounting and that their income and invested capital should be computed accordingly, the Commissioner apparently having used the cash receipts and disbursements method. The testimony consists*3563 largely of accounting figures read into the record, and exhibits consisting of sheets from accounting books. These do not, however, tell the story completely. Such argument as was made throws no light on how the petitioners themselves interpreted this testimony in reaching their conclusion that the accrual method prevailed. They maintain that the Spring Company had accounts receivable in 1920, which were summarized on its general books, although the details were kept in the auxiliary ledgers at the branches; also that it kept inventories, and that the existence of accounts receivable and inventories are consistent only with the accrual method. They stop short, however, of showing just how the accounts receivable were treated in computing income. The balance sheets indicate that they were not included in income in 1919 and 1920; otherwise, they would appear therein as assets and be reflected in surplus. The surplus appearing in these balance sheets, respectively, checks with the profit and loss accounts in the books. This shows that the accounts receivable undoubtedly were not considered in computing income. Its so-called inventory was not a record of goods or materials in stock*3564 used in manufacture. It had no "stock in trade" in the ordinary accounting sense. The article which it dealt in was water, and the water was not inventoried. What it terms an inventory was a statement of the personal property which it owned at each branch office such as machinery, furniture, bottles, crates, horses, automobiles, coolers, and of the accounts receivable. The testimony introduced by petitioner not only fails to prove that the Spring Company was on the accrual basis in 1920, but, on the contrary, shows, we think, that its books were then kept on the cash receipts and disbursements method.
This conclusion is supported by the fact that it made entries in 1921 putting the accounts receivable on the general ledger and including them in surplus for the first time. Under date of January 1, 1921, it made an entry in the profit and loss account, reading, "Additional assets not earnings, $86,686.70." Reference to another page shows this item to be made up as follows: "Supplies, $2,877.07; Coolers, $38,444; Accounts Receivable, $45,365.63." The evidence shows that the accounts were kept on the accrual basis in 1921, and we think this method would correctly reflect its income*3565 for 1921.
*391 The only evidence as to how the Realty Company kept its books is a copy of its profit and loss account. This account does not contain enough information to enable us to determine the question and we make no finding in this regard.
Petitioners contend, however, that accounts receivable should properly be included in invested capital irrespective of the accounting method employed, since they are assets and tangible, and, as they state, represent an investment of cash. They cite section 325 of the Revenue Act of 1918. This is a section of definitions. Section 326 is the one that prescribes what may be included in invested capital. Assets, merely as such, are not included. Invested capital embraces cash and property paid in for stock, or as paid-in surplus, and also earned surplus and undivided profits. Under the cash receipts and disbursements method of accounting, accounts receivable do not enter into earned surplus or undivided profits until after they have been collected. We, therefore, hold that the accounts receivable of the Spring Company are not a part of invested capital for 1920, but that the accounts receivable at the beginning of 1921 may*3566 be included in invested capital for 1921.
The Spring Company charged coolers to expense. They had a life in service of 10 years, and are properly capital assets. At the beginning of 1920 it had thus expended for coolers, $98,643.31. The accrued depreciation thereon was $47,791.95, leaving an unexpired value of $50,851.36. At the beginning of 1921 the total expenditure was $105,995.89; accrued depreciation $58,023.88; unexpired value $47,972.91. However, inventories at the beginning of 1920 and 1921 show that this company had on hand coolers of the value of $38,100 and $38,444, respectively. The discrepancy between the inventories and the unexpired part of the cost at the beginning of each year is not explained. If the difference represented coolers lost or destroyed, deductions should have been made in the year in which the loss or destruction occurred. The total cost of coolers should be reduced by the amount of the discrepancy, both for invested capital and for depreciation purposes.
It is proper to include in invested capital the supplies on hand at the beginning of each of the taxable years, which had been charged to expenses.
The parties have agreed upon the amount*3567 of depreciation to be allowed on part of the property of the Spring Company. In addition to the amounts agreed upon, petitioners claim obsolescence on a building and machinery located on leased ground at Jersey City which had been used as a bottling plant. The purchase of springs at a different location, from which delivery of water would be made directly, rendered this plant no longer of use. In 1920 it was planned to put *392 the springs into use in about three years, and the change was actually carried out in 1923. One-fourth of the depreciated value is a proper deduction for obsolescence in each of the years 1920 and 1921. In arriving at the amount upon which to compute obsolescence, allowance should be made for the machinery salvaged, amounting to $500. Also, the Spring Company is entitled to deduct in 1920 obsolescence for the machinery which was abandoned when it closed its Harlem plant. The Brooklyn plant was closed in 1918, but the machinery was carried on its books until 1920, when it was given away as being worthless. The petitioners seek to deduct its value in 1920 as obsolescence. The evidence indicates that this machinery, while set aside in 1918, was*3568 not discarded until 1920, when it was decided to be worthless. Petitioners are entitled to deduct the depreciated cost of that machinery in 1920.
The petitioners also claim a deduction for obsolescence of horses, wagons, harness, etc., based upon their knowledge in 1920 that they would have to use automobiles instead when the new springs at Morsemere and Shawmont were put into use. We do not think it can be maintained that in 1920 horses and their appurtenant equipment had become obsolete in commercial use. It is undoubtedly true that their employment in trade and commerce had been increasingly curtailed, but we think that we may judicially notice the fact that they had a market value in 1920, with the prospect in that year that they would continue to have a value in 1923 when the Spring Company expected to discontinue their use. There is no testimony as to how they were disposed of or what was realized from them. To entitle the petitioners to this deduction, they would have to show that it was known in 1920 that horses and the equipment that goes with them would be obsolete and have no value (except as scrap) by the time its plans for substitution of automobiles were carried*3569 out. This they have failed to do.
The testimony shows the automobiles had a life in the Spring Company's service of four years, and depreciation thereon on this basis should be allowed.
The remaining question relates to the allowance of depreciation to the Realty Company on buildings. These buildings were all acquired from the Spring Company on March 1, 1918. The basis for determining depreciation is the cost, there being no provision in the 1918 Revenue Act for a different basis in a case like the present one. The Realty Company gave for all the property, embracing land and buildings, its entire capital stock of the par value of $225,000. We have no evidence of the value of the stock, but we may presume that it had no value prior to the exchange, since there were no assets back of it; and that after the exchange its value was substantially the same as the value of the property acquired. This value does not *393 appear. We have in evidence the total cost of each building to March 1, 1913, without any deduction therefrom for depreciation; and a book value to the Spring Company on March 1, 1918, representing balances after the deduction from the several cost figures*3570 of certain amounts for depreciation, which do not appear to have been arrived at according to a consistent method or plan. These figures are of no aid in determining the value March 1, 1918, and we, therefore, do not disturb the allowance for depreciation made by the Commissioner.
Judgment will be entered under Rule 50.