*1836 ADDITIONS TO A RESERVE FOR UNCOLLECTIBLE ACCOUNTS. - Respondent has allowed deductions of additions to the reserve for uncollectible accounts, computing the amounts thereof at a rate of 10 per cent of accounts receivable for the first taxable year, and a rate of 7 per cent for the two succeeding taxable years. Held, upon the evidence, that the rate of 10 per cent is allowable for all three taxable years.
*564 This is a proceeding for the redetermination of deficiencies in income tax determined by the respondent as follows: for 1924, $31.82; for 1926, $425.61.
*565 The petitioner alleges error in the failure to allow as deductions from income in 1924, 1925, and 1926 reasonable reserves for losses from bad debts.
FINDINGS OF FACT.
The petitioner is a North Carolina corporation with principal office at Raleigh, and was incorporated in the spring of 1924 with a paid-in capital stock of $9,100. It has never paid a dividend and has only a small amount of surplus.
The petitioner is engaged in the retail furniture business in an agricultural*1837 community. Its sales are made mostly on an installment basis, with down payments customarily from 7 to 10 per cent of the sale price. Sometimes sales are made without any down payment whatever. The customer usually signs a contract in which the title is reserved to the petitioner and the buyer agrees to make periodic payments. If the promised payments are not made the merchandise is subject to repossession by the petitioner. However, in actual practice the petitioner found it expedient to avoid repossession whenever possible. Many of the accounts are exceedingly slow and difficult of collection. Notwithstanding the endeavor to limit the sales to a basis of payment in full within a period of two years, accounts receivable standing open upon the books at present include balances due on sales made in 1924 and 1925. Business conditions have grown increasingly bad. Of the seven retailers in competition with the petitioner during the taxable years, four have failed.
The accounts of the petitioner were kept upon the accrual basis and a calendar year period. Profits were determined upon the full contract prices of the sales without reference to the deferred installment payments. *1838 In determining what accounts were worthless the books were gone over in detail by the president of the petitioner, a man of long experience in the business, and the amounts charged off were based upon his judgment.
For 1924 the petitioner charged off against profit and loss a reserve of $7,284.34 for bad debts. Worthless accounts in the amount of $1,045.65 were charged against this reserve, but not against profit and loss. Accounts receivable at the end of 1924 amounted to $32,298.35.
For 1925 the petitioner charged off to profit and loss an amount of $2,066.85, worthless accounts, exclusive of accounts upon which repossesions were made, and profit and loss was credited with an amount of $435.40, collections realized on accounts previously charged off. Accounts receivable at the end of 1925 amounted to $40,858.65.
For 1926 the petitioner charged off to profit and loss an amount of $6,684.40 worthless accounts, exclusive of accounts upon which repossessions *566 were made, and an amount of $330.10 was credited to profit and loss for collections on accounts previously charged off as bad. Accounts receivable at the end of 1926 amounted to $44,483.80, comprehensive*1839 of 153 accounts ranging in size from $536 to $1.50.
In 1927 the petitioner charged off to profit and loss an amount of $3,050.31 worthless accounts, exclusive of accounts upon which repossessions were made. An amount of $3,819.22 was credited to profit and loss, inclusive of repossessions entered upon the books in the amount of $1,678.10, the remainder representing collections realized upon accounts previously charged off as bad.
Inventories were priced by the petitioner at cost.
The petitioner filed returns claiming deductions for bad debts and reporting net incomes or net losses as follows: for 1924, amount of reserve for bad debts, $7,284.34; net loss, $582.07; for 1925, worthless accounts in an aggregate of $2,066.85, supported by an itemized schedule of individual accounts; net income, $639.95; for 1926, bad debts in an aggregate of $6,684.40, supported by an itemized schedule of 172 individual accounts; net income, $2,567.84. In determining the tax liabilities the respondent, among other things, has adjusted net income as follows:
| 1924 | 1925 | 1926 | |
| Restore to income deduction claimed | |||
| for bad debts | $7,284.34 | $2,066.85 | $6,684.40 |
| Allow increase in reserve for bad debts | 1 3,229.84 | 1 1,806.11 | 1 3,113.87 |
| Exclude from income bad debts recovered | 435.40 | 330.10 | |
| Net decrease in deduction | 4,054.50 | 3,240.43 | |
| Net increase in deduction | 174.66 |
The tax liabilities of the petitioner have been computed upon revised net incomes amounting as follows: for 1924, $2,254.54; for 1925, $673.62; for 1926, $5,720.53.
OPINION.
TRUSSELL: The sole issue in this case is common to all of the years and relates to the amounts properly deductible by way of allowances for losses from uncollectible accounts. Only the years 1924 and 1926, in which the respondent has determined deficiencies, are directly before us. A consideration of net income or net loss for 1925 enters through the net loss provisions of section 206 of the Revenue Act of 1926.
*567 For 1924 the petitioner reported under a method of accounting which employed a reserve for anticipated losses from bad debts. Although not adhered to by the petitioner in the two succeeding years, this method has been approved by the respondent and followed by him in determining the tax liabilities for the subsequent*1841 years. To this the petitioner agrees. The method is not at issue. We are required to determine what are reasonable additions to the reserve for each year, see the respective sections 234(a)(5) of the Revenue Acts of 1924 and 1926. The amounts of the outstanding accounts receivable at the end of each year are stipulated, and the parties are further in agreement that the additions to the reserve may be conveniently and satisfactorily computed in this case at some rate per cent of the accounts receivable. Thus, the issue is narrowed to a question of the proper rates to be applied. The respondent proposes to allow a rate of 10 per cent for 1924 and a rate of 7 per cent for 1925 and 1926. The petitioner claims that a rate of 20 per cent would be reasonable for all of the years.
We are satisfied that this petitioner, engaged in a retail installment sales furniture business in a rural community, dependent upon agriculture and subject to its vicissitudes, was exposed to a relatively high rate of loss upon its accounts receivable, which are subject to long periods of determent of payment.
We are appreciative of the experience qualifications of the president of the petitioner, who*1842 testified to his opinion that the use of a rate of 25 per cent would have been reasonable in computing the amounts of the additions to the reserves at the times when the books were closed, but we are unable to agree with him, after careful consideration of the evidence in its entirety. We are of opinion, however, that the rate of 10 per cent which the respondent allowed for the first taxable year is reasonable in this case for all of the taxable years, and the net incomes should be recomputed accordingly, giving effect to a net loss for 1925, if any results.
We are not unmindful of the fact that the amount of $6,684.40 worthless accounts charged off in 1926 is in excess of the reserve of 10 per cent which we have concluded to be reasonable. The amount charged off in the instant case was based upon a schedule of some 172 separate accounts, and there is no evidence of any extraordinary developments within the taxable year which would dictate the propriety of an increase over the average reserve. We think the worthless accounts charged off must be considered to reflect the realization of losses previously provided for and there will still remain a balance in the reserve.
Judgment*1843 will be entered pursuant to Rule 50.
Footnotes
1. The respondent states in the deficiency letter that the allowances are based upon the following rates per cent which are applied to the amount of accounts receivable outstanding at the end of each year: For 1924, 10 per cent; for 1925 and 1926, 7 per cent. ↩