Index Notion Co. v. Commissioner , 3 B.T.A. 90 ( 1925 )

OPINION.

James

: _ In its petition taxpayer alleges that the deficiency determined by the Commissioner is predicated upon the following errors:

(a)That the Commissioner erred in increasing the net income as reported in the amended return for 1917 by the sum of $9,708.29, made up as follows:

Reduction in opening inventory_$3, 076. 30

Reduction in purchases_ 3,163. 84

Cash discount earned_ 3, 468.15

9, 708. 29

(b) That the Commissioner erred in increasing the net income as reported in the amended return for 1918 by the sum of $4,564.10, on account of cash discounts earned during the year.

(c) That the Commissioner erred in reducing the invested capital of the years 1918 and 1919, respectively, by the amounts of the deficiencies alleged to be due for the years 1917 and 1918.

The taxpayer further alleges that these errors are the natural consequence of the Commissioner’s action in attempting to determine the net income of each of the years under consideration under the double-entry method of bookkeeping from books which were maintained by the single-entry method.

The evidence in this case discloses that the accounts of this taxpayer were maintained by the single-entry method of bookkeeping, but that memoranda and data outside of the books of account were also maintained, from which it was practicable for the taxpayer to furnish detailed information relating to all items of income and expense entering into the computation of taxable net income.

On the face of the returns of each year, and in the supporting schedules, there is no lack of detail of the various items of income and expense entering into the computation of the taxable net income; and the whole is supported by balance sheets purporting to show the financial condition of the business at the opening and close of ■each year, accompanied by a reconciliation of surplus.

Where books of account are maintained by the single-entry method •of bookkeeping, the determination of net income is made by comparison of the net worth at the close of the year with the net worth at the beginning of the year. The accuracy of the determination depends upon the correctness of the inventories of assets and liabilities at both dates. If the inventories are correct in all respects, then the increase in the net worth of the business plus any unallowable deductions must represent the correct taxable net income.

We have in evidence in this appeal two sets of balance sheets as of the close of each of the years 1916 to 1919, inclusive. Both sets were prepared by the taxpayer, one of which was attached to the returns as filed, while the other was submitted in evidence as taxpayer’s Exhibit No. 1. The two sets are so dissimilar in some respects that, upon comparison, one would hardly suspect that they both emanated from the same business. Their differences have not been accounted for by any evidence whatever. Which of the two sets, if either, correctly reflects the financial condition of the taxpayer at the close of the years 1916 to 1919, inclusive, we must confess we are unable to determine. The mysterious thing about both sets is that, notwithstanding their dissimilarity, both show a surplus in similar amounts at the close of 1919. It is readily apparent that under such circumstances we can not approve the taxpayer’s computations of net income for the several years under consideration, which are based upon a comparison of net worth at the close of each year. •

On the other hand, we are more reluctant to accept the revenue agent’s computations of net income for the years under consideration which have been approved and adopted by the Commissioner. We are not impressed with the accounting gymnastics which he has resorted to in his computations and seriously doubt the correctness of the results obtained thereby. He attempted to verify the items of income and expense appearing on the returns of the several years and found what appeared to him to be discrepancies. These we have outlined in our findings of fact. He accordingly adjusted the net income of each year to take care of these discrepancies, and then, by using the surplus at December 31, 1919, as a starting point, and by working back through a series of additions and subtractions, he established what would have been the surplus at December 31, 1916, if the correct net income of the intervening years was actually as he had computed it. Of course, the net income of each year as he has computed it fits in very nicely with the whole reconciliation of surplus; it could not be otherwise. But the great difficulty with the whole process is that he has not proven the accuracy of the surplus at December 31, 1916, as thus determined, thereby demonstrating the correctness of his computations. What is more, the language used ill his reports and the methods resorted to betray the fact that the discrepancies which he sought to correct existed in his mind only as vague probabilities.

We find further, upon examination of the balance sheets constructed by the revenue agent, evidence of the error of his methods. To make them balance, he found it necessary to include an adjustment account on the liability side of the balance sheets at the close of 1916 and 19 IT in the amounts of $976.09 and $4,419.10, respectively, to take care of amounts otherwise unaccounted for. Had these amounts been permitted to remain in the surplus account, obviously a reconciliation of surplus would have been impossible by using the net income as he determined it for each of the years under consideration.

Forced balance sheets are worthless for any purpose, more especially where they must be used as the basis for the determination of net income under the single-entry method of bookkeeping. We can not sanction the assertion of a deficiency determined under such circumstances. Appeal of Bruce & Human Drug Co., 1 B. T. A. 342.

The additions to net income and the deductions from invested capital made by the Commissioner, as set forth in the findings of fact, are disallowed. Upon the last point in this appeal, our decision must be for the taxpayer. Appeal of Guarantee Construction Co., 2 B. T. A. 1145.