*1509 1. For the years 1925 through 1935 the petitioner valued its inventories of live stock by the constant price method. Such basis was consistently accepted by the respondent for all years except 1935. For 1935 the respondent accepted such basis with respect to three of the petitioner's herds, but as to the other herd determined that the farm price method should be used. Held that the constant price method is not a proper basis for valuing the petitioner's inventories; held, further, that the use of the farm price method is optional with the taxpayer; held, further, that the petitioner, so requesting and showing that cost may be ascertained from its books, is entitled to value its inventories on the basis of cost.
2. The petitioner operates its ranch primarily for the production of calves and for that purpose maintains breeding and growing animals and certain horses and mules in the operation of the ranch. Held, that in computing cost, for inventory purposes, it is proper to apportion to animals born during the year the cost for the year of maintaining the breeding animals; held, further, that death losses during the year (a) on breeding animals may not be*1510 apportioned to animals born during the year, (b) on growing animals may not be apportioned to growing animals surviving the year, and (c) on horses and mules may not be apportioned to breeding and growing animals.
3. Where pursuant to the terms of the will the administration of the estate apparently has not been completed, though 14 years have elapsed since the decedent's death, but the activities of the estate have consisted of carrying on a ranch business and not the preparation of the estate for settlement and distribution, held, that the annual premium paid on the bond of the administrator, appointed subsequent to the death of the executors, is an allowable deduction in computing the net income of the estate.
*385 The Commissioner determined a deficiency of $37,412.37 in the petitioner's income tax for 1935. The issues presented for decision are (1) what the proper basis is for valuing the petitioner's inventories of live stock, and (2) whether the petitioner is entitled to a deduction from income for the*1511 amount paid by it during the taxable year as the annual premium on the bond of the administrator.
FINDINGS OF FACT.
The petitioner, the estate of Mrs. Cornelia Adair, deceased, is being administered under the jurisdiction of the County Court of Armstrong County, Texas, and Montgomery H. W. Ritchie is the duly qualified and acting administrator de bonis non with the will annexed, having been appointed as such by the said court in 1935. The principal office and business address of petitioner is Paloduro, Armstrong County, Texas. The petitioner filed an income tax return for 1935 with the collector of internal revenue at Dallas, Texas, which showed no income tax liability.
Cornelia Adair died September 22, 1921. At the date of her death her principal properties were a large cattle ranch, known as the J. A. Ranch, and a herd of live stock, consisting chiefly of cattle. The ranch comprises 425,590 acres of land situated in the Texas Panhandle, and its headquarters, which are at Paloduro, are approximately 54 miles southeast of Amarillo. The ranch was acquired about 1870 by Mrs. Adair and her husband and originally comprised about 1,000,000 acres of land. Practically all of*1512 the land is fenced off into pastures. It is divided into what is known as the winter range and the summer range. The winter range, which comprises slightly more than one-half of the total acreage, is rough land and lies in the Paloduro Canyon, which runs north and south and divides the ranch into eastern and western portions. The summer range lies to the east of the canyon and the live stock are grazed there during the summer months.
*386 Continuously since the death of Mrs. Adair the estate has been engaged in raising live stock on the ranch. The chief purpose of the business is the production of calves. The estate maintains and operates four herds of live stock; namely, the main cattle herd known as the J.A. herd, the brood cattle herd known as the JJ. herd, the main horse herd, and the brood horse herd.
The main cattle herd, composed of white-faced Hereford cattle, is maintained for the purpose of producing calves. The brood cattle herd is a small herd of pure blood Hereford cattle maintained primarily to supply pure bred bulls for the main herd. The estate raises all of its cows. In order to prevent inbreeding in its brood cattle herd one or two bulls are bought*1513 each year for that herd. Occasionally a car load of bulls is bought for the main herd. The estate is known and referred to by the cattle industry as a cattle breeder, as distinguished from a feeder who purchases cattle and fattens them for sale as beef cattle.
The petitioner has an average of about 10,800 head of cows in the main cattle herd. The cows produce an average of approximately 7,700 calves annually of which about 52 percent are heifers and 48 percent are bulls. The main calving months are March, April, and May, with about two-thirds of the annual calf crop being born prior to June 1 of each year. The petitioner has two round-up periods each year. The first starts in May and is completed by the first week of July. The second starts in September and continues until November. At these round-ups the calves born during the year are segregated from the rest of the cattle. The bull calves are branded, castrated, and turned back on the range and held for sale. The heifer calves are segregated and kept apart from the steer calves, branded, inspected, and turned loose on the range. Those which appear suitable for breeders are retained for that purpose. Those not considered*1514 suitable for that purpose are held for sale with the steer calves. Most of the steer calves born prior to June 1 of each year, together with such heifer calves born prior to such date as it is deemed inadvisable to keep for breeding purposes, are generally sold in November of the year in which they are born. The calves which are not of sufficient size and growth to market in November of the year in which they are born are held on the range and sold as soon as expedient in the following year. From the time heifers are branded until they become two years old they are subjected to inspection to determine their future usefulness for breeding purposes. At the age of one year they are carefully examined and those that it is deemed inadvisable to keep are sold. The same kind of examination is given them when they are two years old. The heifers that are thus culled out are not, therefore, included in the following December 31 annual inventory. It is not *387 possible to gather all the steer calves in a round-up and as a result the petitioner's cattle inventory contains one-year, two-year, and three-year old steers. However as soon as these strays are gathered and gotten to the*1515 delivery point they are sold. In 1935, sometime after July, an actual count was made of the number of cattle on hand and it disclosed about 1,500 head, principally cows and steers, which were not included by the petitioner in its closing inventory for 1934 and which the petitioner did not know that it had. In determining the number of cattle in the inventory at the beginning of 1935, the respondent included said 1,500 head.
A heifer born in a given year is classified as a calf in the closing inventory for that year, as a one-year heifer in the closing inventory for the following year and as a two-year heifer in the closing inventory of the next year. The first two years following the year of birth of a calf are the growing period. A heifer is classified as a breeder at the end of two years following the year of birth and generally produces its first calf at the age of three years, after which time it is classified as a cow. The average life of the cows in the main cattle herd for producing calves is six years. About 1,500 head of the cows in the main cattle herd reach the limit of their productivity each year and are sold and replaced by a like number of young cows which have*1516 been raised on the ranch.
Every year there are a few cattle in the brood herd which are not considered good enough to retain in that herd and they are transferred to the main cattle herd.
The main horse herd consists of horses and a few mules maintained for the use of the cowboys and other employees in their daily work. During the spring and fall round-ups a cowboy generally uses three or four horses a day and each cowboy has a mount of approximately 12 horses. The brood horse herd consists of brood mares and stallions and young growing horses born of such mares. The brood horse herd is maintained to produce horses for the main horse herd. Mare colts born to the brood horse herd are culled over in much the same way as heifer calves in the main cattle herd to select and retain a few that will grow up into good brood mares. Those not selected for retention are sold. The horse colts are made geldings and when they are three years old are broken to ride, after which time they become a part of the main horse herd. The petitioner does not raise, but purchases, stallions for the brood horse herd.
The area in which the petitioner's ranch is situated suffered a severe drought*1517 which began in 1932 and did not break until the spring of 1935. As a result of the drought range conditions became bad, the grass was partially destroyed, and the springs and rivers dried up. In addition dust storms continually occurred in the area. These conditions had a disastrous effect on the petitioner's cattle, *388 increasing the number of deaths, reducing the number of calves produced, and reducing the cattle in weight. On January 1, 1935, the cows in the main cattle herd had an estimated average weight of 650 pounds per head and on December 31, 1935, of 675 pounds per head, whereas in a normal year these cows would have averaged about 750 pounds per head. On December 31, 1935, the estimated average weight of heifer calves was about 320 pounds per head and of the steer calves carried over into 1936 was about 260 pounds. The average weight of steer calves sold during 1935 was 340 pounds per head.
Some breeding and growing animals die each year. For the 10-year period ended December 31, 1935, the average annual amount of losses resulting from the deaths of breeding animals was $24,119.31 and from the deaths of growing animals was $2,773.41. In the main cattle*1518 herd death losses amounted in value to approximately $15,000 in 1933, $29,000 in 1934, $47,000 in 1935, and $19,000 in 1936. Forage and grain consumed in feeding the cattle cost $26,000 in 1933, $29,000 in 1934, $44,000 in 1935, and $19,900 in 1936. The number of calves born was 8,655 in 1933, 8,003 in 1934, 6,311 in 1935, and 9,556 in 1936.
The total expenses of operating the ranch during 1935 amounted to $163,020.23. The various items of expense constituting the foregoing total are apportionable between the breeding and raising activities on the one hand and selling and administrative activities on the other hand as follows:
| Percentages to breeding and raising | Percentages to selling and administrative | |
| Percent | Percent | |
| Salary, ranch superintendent | 80 | 20 |
| Salary, cashier | 100 | |
| Salary, trustee (administrator) | 40 | 60 |
| Salary, cowboys and helpers | 90 | 10 |
| Maintenance of commissary | 90 | 10 |
| Fuel and light | 60 | 40 |
| Forage and grain, property repairs, depreciation, and taxes | 100 | |
| Interest | 100 | |
| General expenses and supplies | A | A |
Mrs. *1519 Adair, from November 30, 1910, to the date of her death in 1921, and her estate since 1921, have continuously maintained books and records relating to the operation of the ranch and its live stock business. Such books have been kept on an accrual basis of accounting and Federal income tax returns have been prepared on that basis since 1916.
In the first income tax return filed by the estate, which covered the period from September 22, 1921 (the date of Mrs. Adair's death), *389 through December 31, 1921, all live stock included in the opening and closing inventories were valued at the following flat prices: Cattle in the main cattle herd, $20 per head; cattle in the brood cattle herd, $27.50 per head; animals in the main horse herd, $40 per head; and animals in the brood horse herd, $30 per head. During the years 1922 through 1924 the cattle were inventoried according to classes and ages at their estimated values for Federal estate tax as of the date of Mrs. Adair's death. When the final values for Federal estate tax of the several classes and ages of cattle belonging to the estate were determined and fixed, these values were consistently used in both the opening and closing*1520 inventories by the petitioner in making its income tax returns for the years 1925 through 1935, with certain exceptions indicated in the footnotes to the following table, which shows the per head values used by the petitioner in computing its opening and closing inventories for the periods indicated:
[Table omitted]
The respondent consistently accepted the basis of inventory values used by petitioner in its returns for 1934 and prior years. Following a revenue agent's investigation of petitioner's return for 1935 the respondent accepted petitioner's constant price method of valuing its inventory of the main horse herd, the brood horse herd, and the *390 brood cattle herd but rejected the use of that basis with respect to the inventory of the main cattle herd, holding that the constant price method of valuing inventories does not clearly reflect income and that its use is prohibited by article 22(c)-2 of Regulations 86, relating to the Revenue Act of 1934. The respondent determined that the farm price method, which provides for the valuation of inventories at market price less cost of disposition, should be used in valuing the various classes of cattle in the inventory*1521 of the main cattle herd. Using the farm price method for valuing cattle in the inventory of the main cattle herd, but accepting the constant price method as used by the petitioner in valuing the livestock in the other three herds of petitioner, the respondent determined the total value of the petitioner's inventory of live stock at December 31, 1934, and December 31, 1935, as follows:
[Table omitted]
*391 By the use of the values of the inventories determined by him, the respondent increased the petitioner's income reported from the cattle business for 1935 by $143,234.04, which was determined as follows:
| Inventory, December 31, 1935, determined by Commissioner | $593,170.52 | |
| Inventory, December 31, 1935, reported in return | 439,400.00 | |
| 153,770.52 | ||
| Increase | ||
| Inventory, December 31, 1934, determined by Commissioner | * $454,399.98 | |
| Inventory, December 31, 1934, reported in return | * 443,863.50 | |
| 10,536.48 | ||
| Net increase in income | 143,234.04 |
*1522 Some cattlemen in the Southwest report their income on the cash receipts and disbursements basis and do not employ inventories. Of those that use inventories in reporting their income, some employ the farm price method in valuing their inventories, while others employ various other methods and at least one uses the cost basis.
The will of Mrs. Adair named Henry C. Coke and T. D. Hobart as independent executors thereof and provided that they should not be required to give bond. In due course the will was admitted to probate by the County Court of Armstrong County, Texas, where the principal part of Mrs. Adair's estate was situated and letters testamentary were issued to said Coke and Hobart. By the will the executors were directed to dispose of all properties as soon after the death of the decedent as they were able to obtain prices deemed by them to be satisfactory, but they were expressly authorized to retain all or any part of the properties until satisfactory prices could be obtained, and while holding the ranch properties they were authorized to manage the ranch and estate and conduct the ranching business as had the decedent during her lifetime. Under the authority contained*1523 in the will, the operation of the ranch has been continued since the death of Mrs. Adair. On July 10, 1933, Coke died and on May 19, 1935, Hobart, the surviving executor, died, and, there being no provision in the will for a successor executor, Montgomery H. W. Ritchie, on June 6, 1935, was appointed and qualified as temporary administrator and on September 12, 1935, was named and qualified as permanent administrator de bonis non, with the will annexed. Before taking charge of the estate's property and the conduct of its affairs in 1935, Ritchie was required to give bond. Ritchie, a grandson of Mrs. Adair, first went to the ranch in 1932, when he became employed there. After taking charge of the estate of Mrs. Adair in 1935, he employed an experienced ranchman by the name of Kent as ranch superintendent. After his appointment as administrator *392 Ritchie devoted approximately 60 percent of his time to matters relating to the sale of cattle and the general conduct and administration of the estate's business and 40 percent to matters relating to the breeding and raising of cattle. Of the total ranch expenses for 1935 of $163,020.23, $1,500 represented the salary of the*1524 administrator of the estate and $3,888.52 represented the salary of the ranch superintendent. Both of said salary items were allowed by the respondent as deductions. During 1935 the income of the estate consisted of $126,599.29 from the sale of cattle (the gross selling price less shipping expenses), $7,501.48 from lease and crop rentals, $45 from interest, and $34.20 from miscellaneous sources.
During 1935 the estate paid an annual premium of $2,484.66 on Ritchie's bond as administrator of the estate and in its income tax return for that year took that amount as a deduction from income. In determining the deficiency the respondent disallowed the deduction on the ground that the amount was applicable to the corpus of the estate and was not a proper deduction against the ranch income.
OPINION.
TURNER: There is no controversy between the parties as to whether the use of inventories of live stock is necessary to the correct determination of the petitioner's income, but they are in disagreement as to the method to be used in valuing such inventories. The respondent contends that the farm price method is the proper method and that his action in using it should be sustained. *1525 The petitioner concedes that it is not entitled to use the constant price method which it employed in filing its return. However it contends now, as prior to the determination of the deficiency, that it is entitled to use cost and that the true cost of its live stock can be ascertained through the use of a method or formula proposed by it and explained as follows:
(1) The cost of a breeding animal, born on the ranch and raised to maturity, is its cost when born plus the cost to raise it during a two year period of growth into maturity as a breeder.
(2) The cost of all calves born during the year is the sum of (1) the cost of maintaining the breeding cattle during the year and (2) the cost value of such number of said cattle as die during the year. The cost of a single calf is the said sum divided by the number of calves born during said year.
(3) The cost of all colts born during the year is the sum of (1) the cost of maintaining the breeding horses during the year and (2) the cost value of such number of said horses as die during the year. The cost of a single colt is said sum divided by the number of colts born during said year.
(4) The cost of raising calves and colts*1526 (sometimes referred to as growing animals) after they are born, and during the two year period before they mature into breeders, constitutes an additional cost of these animals. The cost to be added to said animals each year is the sum of (1) the ranch expenses applicable to said animals and (2) the cost value of such number of *393 said animals as die during the year. The cost to be added to each such growing animal each year is said sum divided by the number of growing animals which survive.
(5) The cost of raising steers after they are born, and during the period they remain unsold, constitutes an additional cost of these animals. The cost to be added to said animals each year is the sum of (1) the ranch expenses applicable to said animals and (2) the cost value of such number of said animals as die during the year. The cost to be added to each such steer each year is said sum divided by the number of steers which survive.
(6) The cost of a growing animal purchased is the actual purchase price plus raising cost. The cost of a grown animal purchased is the actual purchase price.
(7) All ranch expenses, other than selling, general and administrative expenses, *1527 are apportionable on a per head basis each year to the breeding and growing animals. In addition, the cost value of such number of main herd horses (saddle and work horses and mules) as die during the year is so apportionable also.
(8) Ranch expenses constitute two general classes, viz: (1) Breeding and raising expenses and (2) Selling, general and administrative expenses. Class (1) expenses are chargeable to the cost of animals produced and raised in determining gross income from live stock sales. Class (2) expenses are deductible from gross income in determining net income. Certain ranch expenses are direct expenses of breeding and raising animals. Under this class falls forage and grain, repairs to properties, depreciation and taxes. Other ranch expenses are applicable to both said general classes (1) and (2). * * * The table following shows such expenses as are incurred annually and the bases of apportionment:
| Percentages apportion to - | ||
| Nature of Expenses | Breeding and Raising Expenses | Selling General and Administrative Expenses |
| Salaries and wages: | ||
| Ranch superintendent | 80% | 20% |
| Cashier | 100% | |
| Trustees and administrator | 40% | 60% |
| Cowboys and helpers | 90% | 10% |
| Commissary | 90% | 10% |
| Fuel and lights | 60% | 40% |
| Forage and grain | 100% | |
| Repairs to properties | 100% | |
| Depreciation | 100% | |
| Taxes | 100% | |
| Interest | 100% | |
| General expenses and supplies | A | A |
The method or formula of the petitioner provides for the application of the "first in, first out" rule authorized in article 22(c)-2 of Regulations 86 for identifying goods in an inventory where they have become so intermingled as to lose their identity.
The parties have stipulated that if it should be determined that the petitioner is entitled to value its inventories of live stock upon the basis of cost and that the petitioner's method or formula for determining *394 cost is correct, the amounts of $493,173.50 and $525,728.24 shall be accepted as correctly reflecting the values of the petitioner's inventories of live stock at the beginning and end of 1935, respectively.
Section 22(c) of the Revenue Act of 1934 provides as follows:
(c) INVENTORIES. - Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting*1529 practice in the trade or business and as most clearly reflecting the income.
Regulations 86, relating to the Revenue Act of 1934, provides in part as follows:
ART. 22(c)-2. Valuation of inventories. - Section 22(c) provides two tests to which each inventory must conform:
(1) It must conform as nearly as may be to the best accounting practice in the trade or business, and
(2) It must clearly reflect the income.
It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income.
The bases of valuation most commonly used by business*1530 concerns and which meet the requirements of section 22(c) are (a) cost and (b) cost or market, whichever is lower. * * *
In respect of normal goods, whichever basis is adopted must be applied with reasonable consistency to the entire inventory. * * * Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be the goods most recently purchased or produced, and the cost thereof will be the actual cost of the goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired. * * *
The following methods, among others, are sometimes used in taking or valuing inventories, but are not in accord with these regulations, viz: * * *
(4) Using a constant price or nominal value for so-called normal quantity of materials or goods in stock.
* * *
ART. 22(c)-3. 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*1531 discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods.
*395 (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 22(c)-6), (b) miners and manufacturers who by a single process or uniform series*1532 of processes derive a product of two or more kinds, sizes, or grades, the unit cost of which is substantially alike (see article 22(c)-7), and (c) retail merchants who use what is known as the "retail method" in ascertaining approximate cost (see article 22(c)-8).
* * *
ART. 22(c)-6. Inventories of livestock raisers and other farmers. - * * *
Because of the difficulty of ascertaining actual cost of live stock and other farm products, farmers who render their returns upon an inventory basis may value their inventories according to the "farm-price method," which provides for the valuation of inventories at market price less direct cost of disposition. If the use of the "farm-price method" of valuing inventories for any taxable year involves a change in method of valuing inventories from that employed in prior years, permission for such change shall first be secured from the Commissioner as provided in article 41-2. In such case the opening inventory for the taxable year in which the change is made should be brought in at the same value as the closing inventory for the preceding taxable year. If such valuation of the opening inventory for the taxable year in which the*1533 change is made results in an abnormally large income for that year, there may be submitted with the return for such taxable year an adjustment statement for the preceding year. This statement shall be based on the "farm-price method" of valuing inventories, upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at the rate of tax in effect for such preceding year. If an adjustment for the preceding year is not, in the opinion of the Commissioner, sufficient clearly to reflect income, adjustment sheets for prior years may be accepted or required. [Emphasis supplied.]
In filing its return petitioner valued its inventories by the constant price method, which concededly is condemned by the respondent in his regulations and by decided cases, Lucas v. Kansas City Structural Steel Co.,281 U.S. 264">281 U.S. 264; Reynolds Cattle Co.,31 B.T.A. 206">31 B.T.A. 206. Rejecting the constant price method with respect to the main cattle herd and rejecting the contention of the petitioner that it should be permitted to value its entire inventory on the basis of cost, computed according to its formula, the respondent valued the live stock in the main*1534 cattle herd by the farm price method but accepted the petitioner's constant price method for valuing the live stock in the three other herds as used in filing its return. While not conceding error, the respondent offers no explanation of his action in employing such a hybrid method for making his valuation and points to nothing in *396 the record in support of its propriety. It is therefore apparent that consistency was not observed in making the respondent's valuations and that the use of such valuations does not tend to properly reflect income.
In the light of the foregoing situation the first question for decision is what basis or method should be used in valuing petitioner's live stock inventories at the beginning and end of 1935. Obviously the constant price method may not be used. Under the provisions of article 22(c)-6 the use of the farm price method by a taxpayer is not compulsory but is only optional in case he desires to employ it. Here the petitioner does not desire to employ such method and we find nothing in the statute or the regulations which requires that the petitioner should accept its use because of the fact that in prior years, with the respondent's*1535 apparent approval, the petitioner had used a proscribed basis.
As stated in article 22(c)-2, supra, the bases of valuation most commonly used by business concerns which meet the requirements of section 22(c) of the act, supra, respecting conformity to the best accounting practice in the business or trade and the clear reflection of income are (a) cost and (b) cost or market, whichever is lower. From the evidence it appears that there is some diversity of method by which taxpayers engaged in the livestock business in the Southwest value their inventories. While it appears that a substantial number of operators use the farm price method, doubtless due to the fact that it is permitted by the regulations and relieves them of the keeping of cost records, and it further appears that the use of the cost basis is exceptional, probably due to the fact that in the case of the small operators the keeping of the necessary cost records would be unduly burdensome, we do not find anything in the law or regulations which makes that a bar to the use of that basis by those who desire to use it and who are in a position to keept the records necessary for the determination of cost. No contention*1536 is made by the respondent that the bookkeeping system of the petitioner does not contain adequate data from which to determine cost. Since the use of the constant price method of valuing inventories will not correctly reflect income and since the method of valuing inventories at cost is approved by the regulations as being one which will clearly reflect income, we find nothing in the statute or regulations which would prevent a taxpayer who has been using the constant price method from changing to the cost basis if he so desires. Cf. Chicago Frog & Switch Co. v. United States,68 Ct.Cls. 186.
Being of the opinion that the petitioner is entitled to value its inventories on the basis of cost, the next question for determination is whether the use of the petitioner's formula will correctly reflect cost.
*397 The respondent contends that the use of the petitioner's formula in computing cost of its livestock is objectionable for two reasons: (1) Because it apportions to animals born during the year the cost of maintaining the breeding animals, and (2) because it apportions death losses to surviving animals, that is it apportions the cost value, (a) of*1537 breeding animals dying during the year to the animals born during the year, (b) of growing animals dying during the year to the growing animals which survive the year, and (c) of saddle and work horses and mules dying during the year to breeding and growing animals.
Respecting the first objection of the Commissioner, it is to be observed that the petitioner's ranch is operated primarily for the production of calves. The breeding animals therefore are the instruments of production and the animals they produce are the products. The principle contended for by the respondent in his objection would require the maintenance expenses each year of an animal, after reaching the productive state, to be treated as part of its cost so long as it remained in the herd, which would mean until it was worn out or no longer useful as a breeding animal. Proper consideration of the purpose for which the ranch is operated leads, we think, to the conclusion that after a breeding animal reaches the productive state the cost of its maintenance should not be treated as part of and added to its cost, but should fall on the animal which it produces and be treated as a part of the cost of the animal so produced. *1538 In our opinion, after an animal reaches the productive state, expenditures for its maintenance bear a similar relationship to the animals it produces as the expenditures set forth in paragraph (3) of article 22(c)-3, supra, bear to the merchandise there referred to as being produced. The expenditures there mentioned are regarded as constituting part of the cost of the merchandise so produced and we think that here expenditures for the maintenance of the breeding animals are likewise to be treated as a part of the cost of the animals produced.
The respondent's other objection to the use of the formula, because of the manner in which it apportions to surviving animals death losses occurring during the year, is sound. While the evidence shows that death losses are losses recurring year after year in substantial amounts, we fail to see why that fact makes them apportionable to surviving animals as a part of the cost of such animals. While it is true that the breeding animals are maintained as instruments of production and that the animals they produce are the products thereof, yet when a breeding animal dies its usefulness is terminated. The petitioner sustains its loss thereon*1539 at that time and under the statute such loss is deductible in the year in which *398 sustained. Relative to the manner in which such losses are to be deducted, regulations 86 provides as follows:
ART. 23(e)-5. Losses of farmers. - Losses incurred in the operation of farms as business enterprises are deductible from gross income. * * * A farmer engaged in raising and selling stock, such as cattle, sheep, horses, etc., is not entitled to claim as a loss the value of animals that perish from among those animals that were raised on the farm, except as such loss is reflected in an inventory if used. * * * If gross income is ascertained by inventories, no deduction can be made for live stock or products lost during the year, whether purchased for resale or produced on the farm, as such losses will be reflected in the inventory by reducing the amount of live stock or products on hand at the close of the year. * * *
The petitioner has not directed our attention to any authority and we know of none which warrants a holding that death losses from breeding animals in a given year are to be regarded as a part of the cost of the animals born in that year and as such are to be*1540 carried forward and used as an offset against income for a later year or years in which such animals are sold. The petitioner's apportionment of death losses on growing animals, saddle and work horses and mules is objectionable for the same reason.
In a recomputation of the petitioner's tax liability under Rule 50 the inventories will be valued at cost, computed by the petitioner's formula, but so modified as to eliminate from such cost all death losses.
While conceding that he has allowed as a deduction against ranch income the amount paid Ritchie as salary for his services, the respondent contends that Ritchie's bond was given to guarantee his good faith, honesty, and integrity in administering the estate and that the premium paid by the petitioner on such bond is as much an administration expense as are court costs, attorneys' fees, or executors' commissions which are not allowable deductions in determining income and that his action in disallowing a deduction from income of the amount of such premium therefore should be sustained. The petitioner concedes that the bond was a fidelity bond but contends that the premium thereon is just as much a business expense as insurance*1541 premiums against fire, storm, theft, accident, or other similar losses, which are expressly classed as business expenses in the respondent's regulations.
Since the will directed that all properties of the decedent be disposed of as soon as possible after her death but only at prices deemed satisfactory to the executors, and since the ranch was still held and operated in 1935 under the terms of the will, no sale thereof having been made, and since Ritchie was appointed administrator in that year, it appears that administration of the estate had not been fully completed even after the lapse of 14 years. So far as the record shows, nothing was being done during 1935 to prepare the estate for *399 settlement and distribution. Such activities as are disclosed for that year, with the possible exception of the appointment of Ritchie as administrator, indicate that nothing was done except carry on the business. This being the situation, we think the following statements made in George W. Oldham et al., Executors,36 B.T.A. 523">36 B.T.A. 523, 529, are applicable:
* * * Where, however, such fees or commissions [of executors, administrators, attorneys, and other representatives*1542 of estates] are paid for services rendered exclusively in carrying on the affairs of the estate as a business, rather than in preparing it for settlement and distribution, such payments constitute ordinary and necessary expenses and may be deducted for income tax purposes. Grace M. Knox et al., Executors,3 B.T.A. 143">3 B.T.A. 143; William W. Mead et al., Executors, supra; George W. Seligman, Executor,10 B.T.A. 840">10 B.T.A. 840; Henrietta Bendheim,8 B.T.A. 158">8 B.T.A. 158; Charles Lesley Ames, Executor,14 B.T.A. 1067">14 B.T.A. 1067; Margaret B. Sparrow,18 B.T.A. 1">18 B.T.A. 1; Florence Grandin,16 B.T.A. 515">16 B.T.A. 515; Estate of William G. Peckham,19 B.T.A. 1020">19 B.T.A. 1020, 1023; Chicago Title & Trust Co. et al., Trustees,18 B.T.A. 395">18 B.T.A. 395; H. Alfred Hansen, Executor,6 B.T.A. 860">6 B.T.A. 860. * * *
* * * On the other hand, in cases where, according to the provisions of the will or testamentary trust, it is necessary to continue the estate intact over a period of years, and to carry on its affairs as a business in the interim, the fees and commissions paid to representatives of the estate for such services constitute*1543 expenses, deductible for income tax purposes. William W. Mead et al., Executors, supra; H. Alfred Hansen, executor, supra; Florence Grandin, supra; * * *
The respondent having allowed as a deduction from income the salary paid Ritchie in 1935 as administrator, we fail to see why the premium paid for his bond, the furnishing of which was a prerequisite to his acting as administrator, is not also allowable. Both the salary and the bond premium were incurred primarily in connection with the conduct of the petitioner's business. We accordingly hold that the bond premium constitutes an allowable deduction for income tax purposes.
Decision will be entered under Rule 50.
Footnotes
A. Actual allocation based on the nature of each item of expense included under this heading. ↩
*. The parties have stipulated that the correct amount of the petitioner's inventory of live stock at December 31, 1934, upon the basis of the constant price method used by it in valuing its inventory on that date was $493,173.50 instead of $443,863.50 as reported in the return. ↩
A. Actual allocation based upon the nature of each item of expense included under this heading. ↩