PROBLEM 301 Illustration of Borrowed Capital for Purposes of Invested Capital FACTS: The Porter Glass Corporation from time to time needed cash, as its money was largely tied up in accounts receivable and merchandise. As cash was needed the corporation would hypothecate its accounts receivable, upon which a friendly bank would advance the funds required by the corporation. On January 1, 1921, the beginning of the corporation's accounting year, the balance sheet showed accounts payable of $100,000 to the bank. QUESTION: Is this sum a part of the corporation's invested capital for 1921? ANSWER: No. Borrowed money is not a part of invested capital. REFERENCE: Sec. 326 (b): "As used in this title the term 'invested capital' does not include borrowed capital." PROBLEM 302 Illustrating Borrowed Capital Not to be Included in Invested Capital-Debenture Bonds FACTS: The Square Deal Trucking Corporation was organized in 1901. It issued at the time of organization for purposes of having working capital, $150,000 of Gold Debenture Bonds to run for fifty years at 6% interest. The payment of both interest and principal on these bonds ranks with the interest of general creditors. QUESTION: May these bonds be considered as preferred stock and be included in invested capital for 1921? ANSWER: No. These bonds unquestionably represent borrowed capital, which is expressly under the statute excluded from invested capital. REFERENCES: Sec. 325 (a): "That as used in this title . . . The term 'borrowed capital' means money or other property borrowed, whether represented by bonds, notes, open accounts, or otherwise. Sec. 326 (b) (Quoted under Problem 301) Art. 812, Regulations 62: "Any interest in a corporation represented by bonds, debentures, or other securities, by whatever name called, if with respect to the payment of either interest or principal it ranks with or prior to the interest of the general creditors, is borrowed capital and cannot be included in computing invested capital.” PROBLEM 303 Illustrating Borrowed Capital Which May be Included in Invested Capital-Indebtedness to Stockholders Cancelled FACTS: The Marble Slab Corporation owed its president the sum of $50,000, which represented unpaid salary for 1918, 1919 and 1920. Owing to poor business conditions the corporation could not pay this debt without serious impairment of its financial condition. The president, who owned most of the company's stock, on December 31, 1920, decided to forgive this debt and notified the corporation to that effect. QUESTION: May the corporation consider this $50,000 as invested capital for its accounting year ended December 31, 1921? ANSWER: Yes, the indebtedness thus cancelled becomes paid-in surplus. REFERENCES: Sec. 326 (a): "That as used in this title the term 'invested capital' for any year means: ... (3) Paid-in or earned surplus and undivided profits; not including surplus and undivided profits earned during the year; . . ." Art. 813, Regulations 62: "Whether a given amount paid into or left in the business of a corporation constitutes borrowed capital or paid-in surplus is a question of fact. Thus, indebtedness to stockholders cancelled and left in the business would ordinarily constitute paid-in surplus, while amounts left in the business representing salaries of officers in excess of their actual withdrawals, or deposit accounts in favor of partners in a partnership succeeded by the corporation, will be considered paid-in surplus or borrowed capital according to the facts of the particular case. The general principle is that if interest is paid or is to be paid on any such amount, or if the stockholder's or officer's right to repayment of such amount ranks with or before that of the general creditors, the amount so left with the corporation must be considered as borrowed capital and be so treated in computing invested capital." PROBLEM 304 Illustrating Case in Which Evidences of Indebtedness May be Included in Invested Capital FACTS: The Fernald Fine Chair Company was organized in February, 1919, under the laws of a State which permits the issue of capital stock for promissory notes. The organizers paid for their stock $50,000 in cash and $50,000 in promissory notes bearing interest at the rate of 6% and payable in five years. These notes were all enforcible and were received by the corporation in absolute payment of the stock. The makers of the notes were persons of financial responsibility. QUESTION: May these notes be considered as invested capital? ANSWER: Yes. These notes constitute tangible property paid in. REFERENCES: Sec. 325 (a): "That as used in this title The term 'tangible property' means stocks, bonds, notes, and other evidences of indebtedness, bills and accounts receivable, leaseholds, and other property other than intangible property; . . ." Sec. 326 (a) (2) (Quoted under Problem 297) Art. 833, Regulations 62: "Tangible property paid in: evidences of indebtedness- Enforcible notes or other evidences of indebtedness, either interest-bearing or noninterest-bearing, of the subscriber received by a corporation upon a subscription for stock may be considered as tangible property in computing its invested capital to the extent of the actual cash value of such notes or other evidences of indebtedness at the time when paid in, but only (a) if such notes or evidences of indebtedness could under the laws of the jurisdiction in which the corporation was organized legally be received in payment for stock, and (b) if they were actually received by the corporation as absolute, and not as conditional, payment in whole or in part of the stock subscription." PROBLEM 305 Illustrating the Restoration to Invested Capital of Amounts Written Off in Prior Years Against Tangible Property FACTS: The Safety Banking Corporation in 1915, for purposes of conservatism, wrote down its banking establishment (building, furniture and fixtures) to $1.00. The amount of $499,999 was written off by a charge against surplus. QUESTION: May the amount written off be restored to invested capital for 1921? ANSWER: The $499,999 less depreciation sustained may be restored to invested capital. REFERENCES: Art. 838, Regulations 62: "Only true earned surplus and undivided profits can be included in the computation of invested capital, and if for any reason the books do not properly reflect the true surplus such adjustments must be made as are necessary in order to arrive at the correct amount. Art. 840 Regulations 62: "A corporation's books of account will be presumed to show the facts. If it claims that its capital or surplus account is understated the burden of proof will rest upon it. Additions to such accounts will be accepted to the following extent: .. "Amounts which have been expended before January 1, 1917, for the acquisition of plant, equipment, tools, patterns, furniture, fixtures, or like tangible property, having a useful life extending substantially beyond the year in which the expenditure was made, and which have been charged as current expense, may (less proper deductions for depreciation or obsolescence) be added to the surplus account when such assets are still owned and in active use by the corporation during the taxable year. . . .' PROBLEM 306 Illustrating the Restoration to Invested Capital of Amounts Written off in Prior Years Against Intangible Property FACTS: The Tinker Tin Canning Corporation when it organized in 1894, issued $50,000 of its total of $100,000 capital stock for good will, equal in value to the par of the stock issued for it. The corporation in 1910, charged the good will off to surplus. QUESTION: May this good will be restored to invested capital for 1921? ANSWER: Yes, subject of course to the limitations set forth for intangible property acquired with capital stock. REFERENCE: Sec. 326 (a) (4) (Quoted under Problem 308) Art. 840 (3) Regulations 62: "Amounts which have been expended in the past for intangible property of any kind can be restored to capital or surplus account only to the extent that the corporation specifically paid such amounts for the intangible property as such |