*2278 Certain adjustments made by the respondent in the petitioner's inventories for the taxable years involved herein, disapproved.
*1023 *1024 This is a proceeding for the redetermination of deficiencies in income and profits taxes, asserted by the respondent for the years, and in the amounts, as follows:
| Fiscal year ended: | Deficiency |
| Jan. 31, 1919 | $20,205.99 |
| Jan. 31, 1920 | 475.75 |
| Jan. 31, 1921 | 912.85 |
Of the twenty-six assignments of error made in the petition, all but one were waived by the petitioner at the hearing. The one question remaining for decision is whether the respondent erred in increasing the inventories for the taxable years on appeal by the amounts deducted by petitioner for cash discounts.
FINDINGS OF FACT.
The petitioner, a Texas corporation with its principal office at Abilene, is engaged in the wholesale grocery business. It maintains about 20 branch establishments scattered throughout the western part of Texas.
During the taxable years in question, the petitioner*2279 maintained, as a part of its accounting system, a so-called cost book, in which all commodity purchases were recorded at invoice price, plus freight and less cash discounts taken. As purchase market prices advanced or declined, entries were made in this book recording the advance or decline in the market value of the commodities on hand. Fluctuations in purchase market prices of commodities in which the petitioner dealt were frequent during the years in question.
Prior to 1913 petitioner adopted the inventory practice of valuing goods on hand at the close of the year at market prices, less 1 1/2 per cent to take care of cash discounts. The inventories for the taxable years on appeal, except that for the fiscal year ended January 31, 1919, were valued in accordance with this practice. The inventory for the fiscal year 1919 was recorded on the ledger at the gross market price, without any deduction for cash discounts; but this was an inadvertency, and when discovered shortly after closing the books for that year it was corrected by a ledger entry reducing the inventory value by 1 1/2 per cent.
Before adopting the inventory practice outlined in the preceding paragraph the petitioner*2280 examined its purchase invoices covering a considerable period of time, and determined that 1 1/2 per cent was a fair average of cash discounts customarily allowed by the trade for prompt payment. These discounts varied from 1 to 5 per cent. During the years on appeal it was a trade custom in the territory served by petitioner for wholesale grocers to allow a cash discount of 1 1/2 per cent on transactions with others in the wholesale trade. Petitioner has consistently taken advantage of most, if not all, cash discounts offered.
*1025 The detailed inventory records for the years on appeal can not be found, though diligent search has been made for them.
The respondent increased the inventories for the fiscal years 1919, 1920, and 1921, by the amounts of $24,017.25, $27,455.58, and $26,504.98, respectively. The inventory adjustments made by the respondent have resulted in increasing the net incomes for the fiscal years 1919 and 1920 by the amounts of $24,017.25 and $3,438.33, respectively, and in decreasing the net income for the fiscal year 1921 by the amount of $950.60.
OPINION.
MARQUETTE: The question for decision is whether the average cash discounts allowed*2281 to petitioner for prompt payment of invoices should be deducted in arriving at the market value of its inventories for the taxable years on appeal. The petitioner contends that they should be, because that has been its consistent inventory practice at least since 1913, and net income is clearly reflected thereby. On the other hand, the respondent contends that such discounts should not be deducted, because that would constitute a reversal of petitioner's inventory practice of prior years, and result in distorting the income of the taxable years on appeal.
Several witnesses called by the petitioner testified as to facts which indicate very clearly that the petitioner has consistently deducted the average cash discounts in arriving at the market values of inventories for all years since 1913. The respondent called the examining revenue agent to the stand, who testified to facts which tend to show that the practice of deducting average cash discounts was first adopted in valuing the inventory for the fiscal year 1919. Suffice it to say, we have given very careful consideration to the testimony of all of these witnesses, giving to the testimony of each the weight to which we think*2282 it is entitled, and our conclusion is that the petitioner has consistently deducted the average cash discounts allowed to it in computing the values of its inventories for all years since 1913.
In , we had occasion to express our opinion as to the proper treatment of cash discounts in the valuation of inventories. We there stated as follows:
Two methods of accounting for purchase cash discounts are in general use in business, and both have their advocates among the leading accounting authorities. Under one method, the discounts are deducted from the invoice prices and only the net amounts are charged against purchases. Under the other method, the gross invoice prices are charged against purchases and cash discounts allowed are accounted for as financial income arising from the employment of business funds. It was undoubtedly in recognition of the fact that both of these methods were in general use, and that the effect of either on net income is the same, that taxpayers were extended the option in *1026 article 1583 of Regulations 45 to deduct or not to deduct from invoice prices the cash discounts approximating*2283 a fair interest rate, provided a consistent course is followed. In the assignment of values to merchandise in the inventory at the close of the year due regard must be had for the method followed in the treatment of cash discounts. If cash discounts are deducted from invoice prices and only the net amounts are charged against purchases, a like procedure must be followed in the valuation of inventories and merchandise included therein priced at the net invoice prices. * * *
Stated briefly, the rule is that whatever the method employed in accounting for cash discounts, it must be consistently applied in the entire scheme of accounting which included the valuation of the inventories on hand at the close of the year.
In this case, the petitioner has accounted for its purchases at the net invoice price, i.e., invoice prices less cash discounts; hence, its inventory practice of deducting cash discounts in arriving at the market values of its inventories conforms with the rule announced above, and clearly reflects its net income.
Furthermore, the respondent's action in increasing the closing inventory for 1919 by the amount of average cash discounts deducted by the petitioner, *2284 without making a like adjustment in the opening inventory, has resulted in a gross distortion in the income of that year, and, consequently, is in error. Cf. ; ; ; ; ; and .
In his brief filed after the hearing, the respondent takes the position that the petitioner can not prevail, because, whether or not it consistently deducted cash discounts in the valuation of inventories, the valuation on a market basis, regardless of whether cost or market was lower, is not sanctioned by law or regulations. Aside from the fact that this raises a new issue not heretofore presented by the pleadings, it seems to us to be a rather incongruous position for the respondent to take, for it constitutes an attack upon his own action. The effect of respondent's action in increasing the inventories by the amounts deducted by the petitioner for cash discounts was to restate the inventories at the gross*2285 market prices. The sole difference between the parties was a mere matter of whether or not it was necessary to deduct the average cash discounts in order to correctly value the inventories on a market basis. Furthermore, there is no evidence whatever in the record upon which the inventory values can be determined upon any other basis.
Judgment will be entered under Rule 50.