*2647 INVENTORIES - REDUCTION BY ALLOWANCE FOR CASH DISCOUNTS. - Where it appears that the reductions claimed are substantially correct they will be allowed even though they are arrived at by a summary average computation.
*120 This proceeding results from the determination of a deficiency in income and profits taxes for the fiscal year ended January 31, 1922, amounting to $158.84.
The petitioner alleges error as follows:
The failure of the Commissioner in the prior years 1917 to 1920 and in the present year, to allow the taxpayer to price inventories at net value through deduction of cash discount instead of gross value.
FINDINGS OF FACT.
The petitioner is a Massachusetts corporation, with its principal place of business at Brockton. The petitioner is in the mercantile business, operating a retail store of 32 departments. Beginning as far back as 1896 the petitioner has been accustomed to paying cash for its purchases in a manner to avail itself of discounts allowed for prompt payment. These discount rates*2648 varied in relation to fixed periods within which payment was made; the shorter the period the greater the discount allowed. The amounts of the annual purchases and of the aggregate discounts were separately accounted for on the books. Inventories were taken annually by physical count and inspection. These inventories were valued and entered upon the books prior to 1921, at cost, after the following method; the merchandise on hand was priced at invoice cost without deduction for cash discounts; from the aggregate of this cost an allowance for cash discount was deducted at the average rate of cash discounts to purchases for the year, arrived at by dividing the total purchases into the total cash discounts. During 1920 a revenue agent notified the petitioner that this practice would not be allowed by the Department and the inventories should be entered upon the books and reported in the returns at the amount of the invoice costs without deduction of the average cash discount. The petitioner continued to price its inventories after the original manner, but it complied with the direction of the revenue agent and entered upon its books and reported in its *121 return for the*2649 fiscal year ended January 31, 1922, the inventories of January 31, 1921, and January 31, 1922, upon a basis of the invoice cost without deduction for cash discounts.
The books of account reflected the following amounts:
| January 31, 1921 | January 31, 1922 | |
| Inventory | $279,115.22 | $280,655.52 |
| Purchases for fiscal year | 826,063,89 | 722,039.96 |
| Cash discounts earned during year | 19,346.94 | 22,545.14 |
| Accounts payable | 15,076.83 | 36,342.21 |
| Approximate amount of cash on hand | 45,000.00 | 88,000.00 |
The rates of cash discount earned during the taxable year ranged from 2 per cent to 10 per cent.
In computing for its own purposes the deductions of cash discounts from the opening and the closing inventories for the taxable year the petitioner determined the deductions according to the several departments, but these were checked by and satisfactorily reconciled with the average rates of 2.34 per cent for the opening inventory and 3.12 per cent for the closing inventory obtained by dividing the aggregate cash discounts earned by the amount of the purchases for each of the respective years.
The respondent has refused to allow the petitioner to place upon its books*2650 or on its tax return its inventories at a value less average cash discounts.
In determining the deficiency the respondent computed income as follows:
| Income reported on return | $36,106.46 |
| Add: | |
| Excessive depreciation | 362.94 |
| Capital expenditures | 420.00 |
| 36,889.40 | |
| Deduct: | |
| Discounts received overstated through error | 628.94 |
| Corrected net income | 36,260.46 |
OPINION.
TRUSSELL: The allegation of error makes reference to prior years, but these are not before us. The sole issue in this proceeding is the propriety of allowing the deductions from the opening and the closing inventories of the petitioner for the year ended January 31, 1922, of amounts of cash discounts arrived at by a process of averaging.
Section 203 of the Revenue Act of 1921 provides for the use of inventories whenever they are necessary in order to determine clearly the income, and it leaves to the Commissioner, with the approval of *122 the Secretary, the duty of prescribing such bases as will conform as nearly as may be to the best accounting practice in the trade or business, and also as most clearly reflecting income.
The regulations of the Commissioner are published in Regulations*2651 62, articles 1581 to 1588, inclusive. A perusal of these articles makes plain the reason for the use of the word "clearly" throughout section 203 of the statute rather than "exactly" or "accurately." At best, the average retail inventory, due to the physical difficulties involved in its taking and to the necessity for the exercise of experienced personal judgment, can be but an approximation.
We select from the articles of the regulations the following, as of particular reference to the issue here under consideration:
ART. 1582. * * * An inventory that can be used under the best accounting practice in the balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income. * * *
ART. 1583. Inventories at cost. - Cost means:
(1) In the case of merchandise on hand at the beginning of the taxable year, the inventory price of such goods.
(2) In the case of merchandise purchased since the beginning of the taxable year, the invoice price less trade or other discounts, except strictly cash discounts, approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent*2652 course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods.
(3) In the case of merchandise produced by the taxpayer since the beginning of the taxable year (a) the cost of raw materials and supplies entering into or consumed in connection with the product, (b) expenditures for direct labor, (c) indirect expenses incident to and necessary for the production of the particular article, including in such indirect expenses a reasonable proportion of management expenses, but not including any cost of selling or return on capital, whether by way of interest or profit.
(4) In any industry in which the usual rules for computation of cost of production are inapplicable, costs may be approximated upon such basis as may be reasonable and in conformity with established trade practice in the particular industry. Among such cases are (a) farmers and raisers of live stock (see article 1586), (b) miners and manufacturers who by a single process or uniform series of processes derive a product of two or more kinds, size or grade, the unit cost of which is substantially alike (see article*2653 1587), and retail merchants who use what is known as the "retail method" in ascertaining approximate cost. See article 1588.
In , we had occasion to discuss at length the present status of accounting practice with relation to cash discounts. Accounting authorities differ. The division of opinion among the accountants is reflected in the option allowed in the regulations to either deduct or not deduct the cash discounts, provided whatever method is selected be consistently followed every year. The petitioner thoroughly qualifies in consistency; the method it contends for has been followed for many years *123 with the exception of the taxable year when the respondent refused to allow it. Since petitioner clearly had the right under the regulations to deduct the cash discounts, the issue as it presents itself to us is largely if not entirely one of fact.
The facts are undisputed and are set out in full in the findings. The petitioner seeks to deduct from invoice prices, for inventory purposes, summary averages representing allowances for cash discounts rather than exactly the discounts actually allowed. We have*2654 had occasion to consider similar issues repeatedly, and have uniformly decided that, where it appeared that substantial accuracy had been achieved, the averaged allowances for cash or other discounts should be allowed as reductions of the inventories there under consideration. ; ; ; . In the instant case it is possible to distinguish points at which the averages as applied to the whole inventory manifestly must depart somewhat from strict exactitude. Nevertheless, we are satisfied that the allowances are substantially correct, and we think deducting them from the inventories more clearly reflects income and financial position than does the method of the respondent. In our opinion, the cost of goods sold should be revised to give effect to the reductions of the opening and closing inventories by the allowances for cash discounts claimed by the petitioner.
Judgment will be entered under Rule 50.