1931 BTA LEXIS 1646">*1646 Where method of accounting was changed by taxpayer January 1, 1924, from cash receipts and disbursements basis, to an accrual basis, held, items actually accured in 1923, some of which were reported as income in 1923 income-tax return, are not deductible in 1924.
24 B.T.A. 412">*412 This is a proceeding for the redetermination of petitioner's tax liability for the year 1924, for which the respondent has asserted a deficiency in the amount of $2,617.12.
Petitioner assigns the following errors in its amended petition:
(1) The disallowance by respondent of certain net deductions in 1924 based on journal entries representing amounts entered as revenue on the books of petitioner in 1923 when petitioner first kept its books of account on an accrual basis, but not entered as income on an accrual basis until 1924 when the petitioner first made its income-tax return on an accrual basis, and items of deduction which were accrued on the books of petitioner in 1923, but which did not accrue for income-tax purposes until 1924 in the aggregate1931 BTA LEXIS 1646">*1647 amount of $32,298.21; and
(2) The deficiency assessment fails to take into account the net loss in the amount of $22,721.84 suffered by the petitioner in 1923
FINDINGS OF FACT.
The petitioner is a Michigan corporation, with its principal office at Wells, Delta County, Mich.
Prior to 1923 and for the year 1923, petitioner made its income-tax returns on the cash receipts and disbursements basis. Permission to change the method of computing net income and rendering income-tax returns of 1923 and subsequent years was requested by 24 B.T.A. 412">*413 the petitioner January 23, 1924. This request, with reference to the year 1923, was denied by the Commissioner. March 18, 1924, upon petitioner's request therefor, permission was granted by the Commissioner to petitioner to compute its net income and render its income-tax return for the year 1924 and subsequent taxable years on an accrual basis.
Commencing January 1, 1924, for income-tax purposes, the method of accounting employed by petitioner was changed from the cash receipts and disbursements basis to an accrual basis, and petitioner filed its 1924 income-tax return on that basis.
Attached to the 1924 return were Exhibits F and1931 BTA LEXIS 1646">*1648 F-1 to F-5, inclusive, showing the entries made on the books of petitioner, after closing December 31, 1923, on a cash basis, to place the accounting on an accrual basis for 1924.
Exhibit F is as follows:
Summary of Journal Entries which were placed on the books as of December 31st, 1923 which had the effect of changing the practice of accounting from a cash to an accrual basis.
These entries were made after closing the books on cash basis for Income Tax Returns.
| Income | ||
| Debit | Credit | |
| Journal entry #311 | $10,909.60 | |
| Journal entry #312 | $13,501.28 | |
| Journal entry #313 | 18,596.93 | |
| Journal entry #314 | 235.00 | |
| Journal entry #315 | 216.65 | |
| Journal entry #316 | 200.00 | |
| Net debit to income | 20,936.96 | |
| 32,298.21 | 32,298.21 |
The net debit to income, $20,936.96, was disallowed by the respondent in 1924 as a deduction.
Following are the six journal entries made as of January 1, 1924:
| (1) Journal Entry No. 311. | |||
| December 1923 | DEBIT | CREDIT | |
| Intransit Freight Revenue | $10,909.60 | ||
| Joint Freight Revenue | $10,909.60 | ||
| To take into account on | |||
| an estimated basis revenue on | |||
| Interline Forwarded freight | |||
| waybills billed prior to midnight | |||
| December 31st, 1923 and not | |||
| reported by Foreign lines. | |||
| Sept. 1923 and Prior | 162 Tons | ||
| Oct. 1923 and Prior | 423 Tons | ||
| Nov. 1923 and Prior | 2,874 Tons | ||
| Dec. 1923 and Prior | 10,178 Tons | ||
| 13,637 Tons | at 80?? ton | $10,909.60 |
1931 BTA LEXIS 1646">*1649 24 B.T.A. 412">*414 The statement, "This entry to place statement of accounts on accrual basis," appears on all of the journal entries.
This entry represents earnings of petitioner in December, 1923, and prior months, not stated on the books, and accordingly was set up as earned in the respective amounts. It is the proportion of moneys collected by others on interline forwarded tonnage which petitioner carried in September, October, November and December, 1923, but which foreign lines did not report, and petitioner did not receive, until January, February and March of the succeeding year.
| (2) Journal Entry No. 312 | ||
| December 1923 | DEBIT | CREDIT |
| Joint Freight Revenue | $13,501.28 | |
| Intransit Freight Advances | 244.59 | |
| Intransit Freight Prepaid | $13,745.87 | |
| To set up in the books proper asset and | ||
| liability accounts to record the assets of | ||
| this company thru unreported freight | ||
| advances by foreign lines, and the | ||
| liabilities of this company thru | ||
| unreported freight prepaid. | ||
| Detail list on file. |
This entry represents amounts collected by agents of petitioner covering prepaid interline forwarded freight which had been credited to revenue in December, 1923, and1931 BTA LEXIS 1646">*1650 prior months, but was paid to foreign lines in January, 1924, and subsequent months. These were funds reported in petitioner's 1923 tax return as income.
| (3) Journal Entry No. 313 | DEBIT | CREDIT |
| December 1923 | ||
| Joint Freight Revenue | $15,079.72 | |
| Traffic & Car Service Balances | 1,606.79 | |
| Receivable | ||
| Hire of Freight Cars | 3,517.21 | |
| To Traffic & Car Service | $20,203.72 | |
| Balances Payable | ||
| To take into account our summaries | ||
| covering Interline Freight | ||
| for month of December 1923. | ||
| Details attached. |
This entry represents an adjustment of freight charges which were collected on interline received freight in December, 1923, and prior months, and treated as income in 1923. A portion of this money was paid to foreign lines subsequent to January 1, 1924. It also represents per diem and mileage due foreign lines for hire of equipment on petitioner's rails in December, 1923, which under a cash basis, would be entered on the books in 1924. This $15,079.72 was included as income in petitioner's 1923 tax return. This is the first entry made on the books of petitioner to take items of this character out of income and to set them up into agency accounts.
| (4) Journal Entry No. 314 | DEBIT | CREDIT |
| December 1923 | ||
| U.S. Post Office Department | $235.00 | |
| To Mail Revenue | $235.00 | |
| To take into account December | ||
| 1923 Mail Revenue appearing in | ||
| January 1924 Cash Book Applicable | ||
| to period ended December 31st | ||
| 1923 |
1931 BTA LEXIS 1646">*1651 24 B.T.A. 412">*415 This entry represents an estimated amount of mail revenue due from the United States Government for December, 1923, and not received until January or February, 1924.
| (5) Journal Entry No. 315 December 1923 | DEBIT | CREDIT |
| Cleveland Cliff Iron Co | $216.65 | |
| To Miscellaneous Income | $216.65 | |
| October 1923 | ||
| November 1923 | ||
| December 1923 |
This entry represents an amount due from the Cleveland Cliff Iron Company which was earned in the last quarter of 1923 but not received until 1924.
| (6) Journal Entry No. 316 | DEBIT | CREDIT | |||
| December 1923 | |||||
| Transportation Expenses | $170.00 | ||||
| Operating Joint Yards & | $165.00 | ||||
| Terminal Dr. | |||||
| Water for Train Locomotives | 5.00 | ||||
| Joint Facility - Rents | 30.00 | ||||
| To Other Unadjusted Credits | $200.00 | ||||
| Auditors Suspense Account | 200.00 | ||||
| To take into account CM&STP | |||||
| Ry. Co. delayed bills for | |||||
| November and December 1923 | |||||
| for use of terminal | |||||
| facilities at Channing, | |||||
| Michigan | |||||
| November 1923 | $100.00 | ||||
| December 1923 | 100.00 | ||||
| $200.00 |
This entry represents expense of $100 a month for November and December of 1923, covering the Channing, Mich., terminal. These1931 BTA LEXIS 1646">*1652 items were paid in January or February, 1924. The $30 represents joint facility rents and the $170.00 is for transportation expense.
The net total of these six journal entries, $20,936.96, was disallowed by the Commissioner as a deduction in 1924.
The net total of these six journal entries in the amount of $20,936.96 was included in income in petitioner's tax return for 1923, and amounts received and reported as income in 1922 and paid out in 1923, representing similar transactions, were deducted in tax return of 1923. These transactions were treated in the same manner in previous years, i.e., reported as income in the year received and deducted in subsequent years.
The change from a cash basis to an accrual basis for purpose of reports to Interstate Commerce Commission was made as of December 24 B.T.A. 412">*416 31, 1923. Reports of income for 1923 and 1924 were made on an accrual basis by petitioner to the Interstate Commerce Commission. The net income from operations thus reported in 1924 was $60,653.98, and exceeds the taxable income shown in the income-tax return for same year by $19,790.13. In the report to the Interstate Commerce Commission the profit and loss accounts1931 BTA LEXIS 1646">*1653 and income accounts are combined. The following statement shows a reconciliation of the different amounts reported as income to the Interstate Commerce Commission and Commissioner of Internal Revenue:
| Net Income from Operations (Accrual) | ||
| Basis (Year 1924) as per Exhibit G | Credit | $60,653.98 |
| Profit and Loss Items - as per Exhibit C | ||
| Profit on Road and Equipment sold | Credit | 2,251.74 |
| Miscellaneous Credits | Credit | 2,400.18 |
| 65,305.90 | ||
| Loss on Road and Equipment | Debit | 8,859.55 |
| 56,446.35 | ||
| Entries affecting change from cash Basis of | Debit | 20,936.96 |
| Accounting Dec 31, 1923 (Income Tax Return | ||
| Basis 1923) to Accrual Basis of Accounting Dec. | ||
| 31, 1923 (Report to Interstate Commerce | ||
| Commission) as per Exhibit F | 35,509.39 | |
| Add Income Taxes accrued 1924 which were | Credit | 5,354.46 |
| deducted from Income, but not to be allowed | ||
| for Income Tax Returns as per Exhibit E | ||
| Taxable Gain 1924 | 40,863.85 |
OPINION.
McMAHON: The second assignment of error was not referred to at the hearing and not dealt with in the briefs of counsel. Sufficient evidence was not presented from which it can be determined that respondent was in error as alleged in1931 BTA LEXIS 1646">*1654 petitioner's second assignment of error.
The only question, then, to be determined in this proceeding is whether items which accrued in 1923, some of which were reported as income in the 1923 income-tax return, are deductible in 1924, the
MCMAHON: The second assignment of error was not referred to at receipts and disbursements basis.
Petitioner changed its method of accounting upon its own volition on January 1, 1924, from a cash receipts and disbursements basis, used in 1923 and prior thereto, to an accrual basis. The transaction giving rise to the items involved occurred in 1923. It is contended by petitioner that these items could not be accrued prior to January 24 B.T.A. 412">*417 1, 1924, because petitioner's method of accounting was on a cash basis. This contention offers no sound reason for the deduction of these items in 1924.
The law provides that in computing net income of a corporation subject to tax there shall be allowed, among other deductions specified, all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.
Section 212(b) of the Revenue Act of 1924 provides that the net income of a corporation shall1931 BTA LEXIS 1646">*1655 be computed in accordance with the method of accounting employed in keeping the books of the corporation, providing the method used clearly reflects the income of the taxpayer.
Journal entries Nos. 312 and 313 represent items in substantial amounts which were treated as income by petitioner in 1923 and prior thereto, when in fact such items represented moneys collected by agents of petitioner covering prepaid interline forwarded freight immediately due foreign lines, but not paid until the following year. The amounts credited in one year as income were deducted the following year as expense. It is stated in , as follows:
* * * Nor do we think the method of bookkeeping employed in accounting for discount could make income if it did not fall within the definition of income. The mere placing of amounts on the books and reporting them as income can not change the facts any more than the placing of losses on the books constitute them proper deductions if they are not such in fact. The facts must control, and bookkeeping entries are only evidence of the facts.
Clearly such items are not ordinary and necessary business1931 BTA LEXIS 1646">*1656 expense and therefore are not deductible as such.
We can not authorize the erroneous computing of income in the taxable year because of erroneous accounting in a previous year. See ; ; and .
Petitioner contends that because these funds were reported in 1923 as income and income taxes were paid thereon, therefore the deduction should be allowed.
In , wherein the taxpayer changed its method of accounting, it was held that all amounts which constituted income within the year under the method of accounting employed must be returned for taxation in that year even though a part thereof was improperly reported as income and the tax paid thereon in a prior year. The fact that petitioner paid taxes on an item erroneously reported as income in a prior year does not make that item an allowable deduction.
24 B.T.A. 412">*418 In , recognizing the effects of a change in method of accounting, it is said:
* * * The difficulty arises through the1931 BTA LEXIS 1646">*1657 change from the cash to the accrual basis, for there is a gap or hiatus between the two methods arising from the change where items of income or deductions are left out. * * *
Yet it holds that where a bank changes its methods of accounting from a cash to an accrual basis, all of its accounts which are accruable must be placed on that basis and it must return as income on the new basis discount earned during the year on bills discounted in the preceding year even though it had erroneously returned such amounts as income and paid the tax thereon in such preceding year.
There is no provision made in law for the allowance in 1924 of items of expense accruing in 1923. See .
Whether the change in method of accounting results in payment of a greater or less amount of tax is not a controlling factor in deciding the question involved. In , it is stated:
* * * The fact that a taxpayer has paid lower taxes for prior years than those which were rightfully due, because of erroneous computations of taxable income, and that the statute of limitations now bars the assessment and collection of any1931 BTA LEXIS 1646">*1658 deficiency for those years, does not justify an erroneous computation of its tax liability for any subsequent year. Appeal of . Income and profits taxes are levied with respect to annual periods, and each annual period must necessarily stand by itself. .
The petitioner contends in its brief that if it could go back to 1923 and eliminate the payments shown as income in that year and thus reduce its income for that year, there would be no objection to the disallowance in 1924 of the deduction, but that this presumably would involve the correction of returns back to the first return filed; and as this is impossible it is equitably entitled to the deduction.
In the case of , the petitioner refused to accede to the adjustment of its returns prior to 1918 to properly reflect income due to change by petitioner in method of accounting. The Commissioner refused to allow change of accounting. The petitioner, in its returns on an accrual basis, included accrued income, but not income collected which accrued in the preceding year. 1931 BTA LEXIS 1646">*1659 Although no adjustment could be made, it is stated:
* * * Whenever the bar of the statute of limitations does not prevent such action, the prior returns should be adjusted so as to show the correct income. The statute appears to have barred any adjustments herein in prior returns, but the situation is a practical one and we think the taxpayer must be permitted to place its books upon a basis which clearly reflects its income. * * *
24 B.T.A. 412">*419 It being shown that the net income reported to the Interstate Commerce Commission was arrived at on a different basis than that shown in the income-tax report, it is immaterial that the net income reported to the Interstate Commerce Commission exceeded the net income reported in the income-tax return.
Reviewed by the Board.
Judgment will be entered for the respondent.
ARUNDELL, VAN FOSSAN, MURDOCK, and GOODRICH concur in the result only.