*1953 INVENTORIES - VALUATION. - In a proceeding reported in 6 B.T.A. 1149, this petitioner brought before us for redetermination the matter of its tax liability for its fiscal years ended March 31, 1918, and March 31, 1920, and in that proceeding the Board determined that petitioner's inventories should be valued on the basis of cost computed upon the factors thereof, which were all shown to be in evidence and satisfactorily derived from the accounts and records of the petitioner. The record in the instant proceeding shows that the same methods of procedure were continued by the petitioner in respect to the inventories of March 31, 1921, and March 31, 1922, and the necessary factors for the computation of true cost have been stipulated by the parties. Held, the inventories of March 31, 1921, and March 31, 1922, should be valued at cost and any net loss for the year ended March 31, 1922, found by the use of inventories so valued, may be carried forward and deducted in the next two succeeding years, as provided in the statutes.
*1359 This*1954 is a proceeding for a redetermination of deficiencies in income tax determined by the respondent in the following amounts: For the fiscal year ended March 31, 1924, $1,541.53; for the fiscal year ended September 30, 1925, $1,429.16.
At the hearing petitioner submitted its case solely upon the issue of the proper valuation of inventories of March 31, 1921, and March 31, 1922, as affecting the questions of net losses for the periods ending on those dates and the reflection of such net losses in the determination of taxable income for the year ended March 31, 1924. All other allegations of error were abandoned.
FINDINGS OF FACT.
The petitioner is a North Carolina corporation with principal place of business at Gastonia.
The findings of fact in the case of Ozark Mills, Inc., Docket No. 4377, published in , were, upon motion, made a part *1360 of the record and of the findings in the instant case, and, so far as material here, read as follows:
In the year 1917 it made changes in its plant, installed new and additional machinery and began the manufacture of high-grade cotton yarn, with what is known as an English process, for use in the*1955 making of soft collars and silk goods. * * * As a part of petitioner's process cotton of many grades was mixed and used at the same time. Never less than ten bales and usually about forty bales were opened at the same time and a certain quantity of cotton was taken from each bale and run through fifteen mixing machines. * * *
The amount of high-priced and low-priced cotton used in the mixture of raw cotton that goes into the yarn depends upon the number of the yarns being manufactured at the time, that is, whether fine or coarse, and the kind of yarn being manufactured at any particular time depends upon market conditions. Because of this condition a supply of cotton of various grades is and was kept on hand sometimes for a period of two years. The keeping of cotton purchased from time to time on hand for a long period of time is further occasioned by the arrangement of petitioner's warehouse facilities. Its warehouse, having a capacity of fifteen hundred bales of cotton, a supply sufficient to run petitioner for six months, has but one opening on the platform alongside the railroad, and as cotton is purchased it is stored as far back in the warehouse as possible for convenience*1956 in storing so that the various grades of the last cotton purchased are stored near the warehouse opening. In withdrawing cotton from the warehouse for manufacturing purposes, the cotton last purchased of the grade required, is used first, leaving the cotton earlier purchased of the different grades in the rear of the warehouse. Petitioner uses from two hundred to two hundred and fifty bales per month.
Prior to and during the taxable years when cotton was purchased petitioner made a record upon its books of account of the date of purchase, the number of pounds, from whom purchased, and the price paid per pound. After purchases were received there was attached to each bale a tag containing this information and petitioner made a record in its cotton book of the particular bales, grade, cost, date of purchase, etc., of cotton withdrawn from the warehouse for manufacturing purposes but in the storing and handling of the cotton some of the tags were detached and lost, and in some instances tags detached by employees when withdrawing cotton from the warehouse never reached the accounting office, consequently no record was made of such withdrawals until a check was made of the cotton*1957 book with a physical inventory.
In the foregoing manner a perpetual inventory was maintained from which it was possible to determine the cost of raw cotton on hand and the cost of cotton entering into the manufacturing process. No physical inventories were taken until March 31, 1920, for the purpose of ascertaining the total cotton on hand and, from the tags which might still be attached, the date of purchase and cost per pound of such cotton. The inventory at March 31, 1920, showed a difference (a decrease) from the perpetual inventory of approximately 48,500 pounds, which difference the petitioner priced by taking the average cost of cotton for the preceding year, and reduced the perpetual inventory by this amount, which resulting amount was used in its original returns as filed. The only other change in the inventories as used in its returns from that shown by the perpetual inventory, of which we have been advised, was at March 31, 1918, when the inventory as shown by the books was reduced $8,863.07 and explained as "reduction in value."
* * *
The *1361 method of calculating waste and the percentage of waste as shown by the petitioner for the various years were*1958 accepted by the respondent at the hearing. Likewise, the petitioner conceded that the corrections which were made by the revenue agent in the raw cotton inventory on account of bales of cotton which had been opened but not yet put in process were correct.
* * *
The various items entering into the manufacturing costs (except the item for depreciation on tenement houses hereinbefore referred to) and the method by which cost of goods in process and cost of finished goods was determined, as shown by the petitioner were accepted by the respondent as being correct.
Further facts from the evidence adduced at the hearing of the instant appeal are found as follows:
For the years 1918, 1919, and 1920, resulting from the decision of this Board in Ozark Mills, Inc., supra, the inventories have been revalued through a computation of true cost as directed in the opinion. Originally in determining the profits upon the books of account the petitioner employed for 1921 and 1922 the same method in valuing its inventories which it had employed for 1918 to 1920, inclusive. The said inventories were not valued at either true cost or market value.
In revaluing the inventory of March 31, 1921, the*1959 respondent has computed the cost as follows: production cost consisting of labor, power, supplies, mill repairs, machinery, depreciation, general expenses, and team expense in an aggregate of $172,383.67; yarn produced 397,279 pounds; cost per pound 43.39 cents; cost of raw cotton 25 cents per pound; total cost of yarn produced 68.39 cents per pound; yarn in inventory March 31, 1921, 305,344 pounds; cost thereof $208,824.76. The cost of 25 cents per pound for raw cotton was adopted upon the recommendation of the revenue agent who made an examination in 1923 and reported that such was the cost of the most recent purchases of the raw cotton.
With respect to its supplies of raw cotton stored in its warehouse, the petitioner was in the same position in 1921 and 1922 as in prior years, having preserved a record of the quality, weight and cost with respect to each bale of raw cotton purchased, used in its manufacturing processes and/or remaining on hand and unused. The same conditions as in 1918, 1919, and 1920 at the warehouse prevailed during 1921 and 1922.
With respect to the fiscal year ended March 31, 1921, the following statement correctly reflects, by stipulation of the parties, *1960 the number of pounds and the values in the aggregates of cotton, cotton in process and yarn:
| Pounds | Value | ||
| Cotton and process: | |||
| Cotton inventory 4-1-20 | 241,919 | 176,610.55 | |
| Cotton purchased | 319,452 | 219,831.36 | |
| 561,371 | 396,441.91 | ||
| Cotton inventory 3-31-21 | 15,429 | 3,857.25 | |
| Cotton consumed | 545,942 | 392,584.66 | |
| Process inventory 4-1-20 | 36,596 | 23,698.84 | |
| Total consumed | 582,538 | 416,283.50 | |
| Less gross waste and value | 152,087 | 8,356.70 | |
| Consumed in yarn and process | 430,451 | 407,926.80 | |
| Manufacturing expenses | 170,102.55 | ||
| Total manufacturing cost | 100.00% | 578,029.35 | |
| Less process inventory 3-31-21 | 7.71% | 33,172 | 32,446.86 |
| Cost of yarn production | 92.29% | 397,279 | 545,582.49 |
| Less yarn inventory 3-31-21 | 305,344 | 419,328.92 | |
| Cost of yarn production sold | 91,935 | 126,253.57 | |
| Add yarn inventory 4-1-20 | 3,534 | 3,486.61 | |
| Cost of yarn sales | 95,469 | 129,740.18 | |
| Yarn sales | 225,755.83 | ||
| Profit from yarn sales | 96,015.65 | ||
| Add other income | 1,904.16 | ||
| 97,919.81 | |||
| Less other expenses | 80,934.43 | ||
| Net income as adjusted | 16,985.38 |
*1362 With respect to the fiscal year ended March 31, 1922, the following*1961 statement correctly reflects, by stipulation of the parties, the number of pounds and the values in the aggregates of the cotton, cotton in process and yarn:
| Pounds | Value | ||
| Cotton and process: | |||
| Cotton inventory 4-1-21 | 15,429 | $3,857.25 | |
| Cotton purchased | 1,293,916 | 425,187.22 | |
| 1,309,345 | 429,044.47 | ||
| Cotton inventory 3-31-22 | 396,331 | 136,096.10 | |
| Cotton consumed | 913,014 | 292,948.37 | |
| Process inventory 4-1-21 | 33,172 | 32,446.86 | |
| Total consumed | 946,186 | 325,395.23 | |
| Less gross waste and value | 263,486 | 19,033.90 | |
| Consumed in yarn and process | 682,700 | 306,361.33 | |
| Manufacturing expenses | 191,498.12 | ||
| Total manufacturing cost | 100.00% | 497,859.45 | |
| Less process inventory 3-31-22 | 4.79% | 32,674 | 15,101.60 |
| Cost of yarn production | 95.21% | 650,026 | 482,757.85 |
| Less yarn inventory 3-31-22 | 85,512 | 63,508.05 | |
| Cost of yarn production sold | 564,514 | 419,249.80 | |
| Add yarn inventory 4-1-21 | 305,344 | 419,328.92 | |
| Cost of yarn sales | 869,858 | 838,578.72 | |
| Yarn sales | 736,027.81 | ||
| Loss from yarn sales | 102,550.91 | ||
| Add other expenses | 81,433.84 | ||
| 183,984.75 | |||
| Less other income | 1,835.13 | ||
| Net loss as adjusted | 182,149.62 |
*1962 *1363 The deficiency letter of June 3, 1927, determined the net incomes of the respective taxable years and period therein considered, as follows: for the fiscal year ended March 31, 1923, adjusted net income $18,495.27 less balance of the net loss of 1921, $22,372.76; leaving taxable net income, none; for the fiscal year ended March 31, 1924, adjusted net income, $43,022.85; for the period April 1 to September 30, 1924, adjusted net loss, $5,923.80; for the fiscal year ended September 30, 1925, adjusted net income, $24,751.34, less net loss for the immediately prior period, $5,923.80, leaving taxable net income, $18,827.54.
In determining the tax liabilities for the fiscal years 1923 and 1924, the fiscal period 1924 and the fiscal year 1925, the respondent has made no adjustment of reported net income on account of a valuation of inventories.
OPINION.
TRUSSELL: The sweeping claims advanced in the petition in this case were waived by the petitioner at the hearing and a single issue was presented for decision. The petitioner claims that its inventory of March 31, 1921, should be revalued upon actual cost by the same method which was approved for prior years in *1963 Ozark Mills, Inc., supra. At the hearing, counsel for the petitioner announced, with the oral approval of the respondent, that the parties are in agreement as to the net incomes for 1923, 1924, and 1925, and the only controversy relates to the net losses for 1921 and 1922, in that the parties do not agree as to the basis of valuation of the inventory of March 31, 1921. The deficiencies which are here under review are for the fiscal years ended March 31, 1924, and September 30, 1925, and the issue thus presented is within our jurisdiction, due to the statutory provision that a net loss for 1922 may be carried forward and applied against the net incomes of the two next succeeding taxable years.
The petitioner is engaged in the manufacture and sale of cotton yarn. During 1918, 1919, and 1920 it computed the value of its inventories by a method which reflected neither actual cost nor market value. However, its method of recording the cost of the identical raw cotton consumed in production was such that the value of the inventories at actual cost can be determined and in fact has been determined, for income tax purposes, in accordance with our decision in Ozark Mills, Inc., supra.*1964 The evidence adduced at the hearing in the instant appeal shows that with respect to the petitioner the same practices prevailed in 1921 and 1922 as in the previous year, so that the original valuation of its inventories during *1364 1921 and 1922 by the petitioner was neither at cost nor at market value, although from its records it was possible to compute the actual cost.
During the fiscal year 1921 the petitioner sold a relatively small quantity of yarn, but it produced in that year a relatively large quantity, with the result that it had on hand on March 31, 1921, an unusually large quantity of yarn. During the fiscal year 1922, the sales were relatively large, being greatly in excess of the yarn produced in 1922, and the valuation of the yarn in inventory on March 31, 1921, is of major effect upon a computation of the amount of gross profit realized in 1922. The so-called cost valuation of the inventory as computed by the respondent is much lower than the valuation now claimed as actual cost by the petitioner. A redetermination of the issue will decide whether net income resulted as determined by the respondent, or a comparatively large net loss was suffered in*1965 1922, as claimed by the petitioner.
The parties have stipulated the true quantities and costs, which will enable a recomputation of the actual cost values of the inventories for March 31, 1921, and March 31, 1922. It further appears that the revaluations of said inventories made by the respondent upon intended cost do not in fact reflect the actual cost. But this does not dispose of the case, because of a contention of the respondent. The respondent now proposes that the inventory of March 31, 1921, as reported in the returns filed by the petitioner, should be allowed to remain unadjusted, on the theory that it was on the basis of the lower of cost or market, or at any event the petitioner has failed to prove exactly the basis. In support of this argument the respondent cites , and , two cases in which we refused to make changes desired by the taxpayers because of a failure to put in evidence the necessary facts. These cases are not in point. In the instant case the respondent has rejected the returns as erroneous and has substituted his own valuations based upon so-called*1966 cost. Now the parties have stipulated facts and figures which enable a computation of true cost. We can not go back to a blind acceptance of the original inventories which we know are neither cost nor market.
The major point in the inventories of 1918, 1919, and 1920, was the preponderance of raw material. We are still without any evidence to show that the petitioner attempted to change its basis for its 1920 inventory to the lower of cost or market, or that all of its prior inventories had been valued on such basis. The petitioner is claiming the cost basis. We pointed out in Ozark Mills, Inc., supra, that in 1920 cost was lower than market. In determining the final *1365 tax liability the 1920 inventory has been valued at actual cost. For 1923, 1924, and 1925 the parties are in agreement as to net income, and the inventories have been accepted as valued by the petitioner at cost. We are satisfied that the consistent use of the cost basis for all of the years, including 1921 and 1922, which are here under consideration, will result in a clear, and therefore satisfactory, reflection of income or of loss. Consideration of the facts which are before us in this*1967 case, after putting away from us presumptions proposed by the respondent which are unsupported by fact or even by probabilities, leads, we think, to the conclusion that the inventory of March 31, 1921, should be valued at actual cost determined in the same manner as authorized for the 1920 inventory. Furthermore, in computing the amount of the net loss for 1922 for the purpose of arriving at the deduction thereof allowable in 1924, consistency requires that the inventory of March 31, 1922, be also valued on the same basis of actual cost.
Decision will be entered pursuant to Rule 50.