exclude from inventory goods sold, title to which has passed to the purchaser. A purchaser should include in inventory merchandise purchased, title to which has passed to him, although such merchandise is in transit or for other reasons has not been reduced to physical possession, but should not include goods ordered for future delivery transfer of title to which has not yet been effected. FACTS: PROBLEM 35 Illustrating Basis for Computation of Inventory The Hartford Metal Company was organized in 1921, for the purchase and sale of certain precious metals. It files its first return for the period beginning with the day of its organization in 1921, to and including December 31, 1921. It has on hand at the close of 1921, a substantial inventory. The company desires information as to the basis for the computation of the value of the inventory. Its own preference is to price the goods in inventory on the basis of market at December 31, 1921, regardless of whether or not market was higher or lower than cost. QUESTION: What advice should be given the corporation in this connection? ANSWER: Inventories are required to be taken by the 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 practice in the trade or business and as most clearly reflecting the income. However, in the past, the Commissioner has given his general sanction to the use of only two methods, to wit: (a) Cost or (b) cost or market whichever is lower. In meritorious cases the Bureau has permitted a deviation from these two methods. If, therefore, the corporation above mentioned believes that its proposed method of inventory taking conforms as nearly as may be to the best account ing practice in the trade or business and most clearly reflects the income, it should state its case to the Commissioner and obtain permission to compute its inventory on the basis of market regardless of cost. If the corporation files its return without a request for a ruling as to how its inventory should be prepared, it is required to price its inventory as set forth at the beginning of this paragraph on the basis of either (a) cost or (b) cost or market, whichever is lower. For the meaning of "cost" and "market" see Articles 1583 given below from Articles 1583 and 1584 of Regulations 62 quoted below. REFERENCE: Articles 1582, 1583 and 1584 of Regulations 62 as follows: Art. 1582. Valuation of inventories.-The Act 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 can not 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 to clearly 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 basis of valuation most commonly used by business concerns and which meets the requirements of the Revenue Act is (a) cost or (b) cost or market, whichever is lower. . . . Any goods in an inventory which are unsalable at normal prices or unusable in the normal way because of damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes, including secondhand goods taken in exchange, should be valued at bona fide selling prices less cost of selling whether basis (a) or (b) is used, or if such goods consist of raw materials or partly finished goods held for use or consumption, they should be valued upon a reasonable basis, taking into consideration the usability and the condition of the goods, but in no case shall such value be less than the scrap value. Bona fide selling price means actual offerings of goods during a period ending not later than 30 days after inventory date. The burden of proof will rest upon the taxpayer to show that such exceptional goods as are valued upon such selling basis come within the classifications indicated above, and he shall maintain such records of the disposition of the goods as will enable a verification of the inventory to be made. In respect to normal goods whichever basis (a) or (b) is adopted must be applied with reasonable consistency to the entire inventory. Taxpayers were given an option to adopt the basis of either (a) cost or (b) cost or market, whichever is lower, for their 1920 inventories, and the basis adopted for that year is controlling and a change can now be made only after permission is secured from the Commissioner. Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be either (a) 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, or (b) where the taxpayer maintains book inventories in accordance with a sound accounting system in which the respective inventory accounts are charged with the actual cost of the goods purchased or produced and credited with the value of goods used, transferred, or sold, calculated upon the basis of the actual cost of the goods acquired during the taxable year (including the inventory at the beginning of the year) the net value as shown by such inventory accounts will be deemed to be the cost of the goods on hand. The balances shown by such book inventories should be verified by physical inventories at reasonable intervals and adjusted to conform therewith. Inventories should be recorded in a legible manner, properly computed and summarized, and should be preserved as a part of the accounting record of the taxpayer. The inventories of taxpayers on whatever basis taken will be subject to investigation by the Commissioner, and the taxpayer must satisfy the Commissioner of the correctness of the prices adopted. The following methods, among others, are sometimes used in taking or valuing inventories, but are not in accord with these regulations, viz: (a) Deducting from the inventory a reserve for price changes, or an estimated depreciation in the value thereof. (b) Taking work in process, or other parts of the inventory, at a nominal price or at less than its proper value. (c) Omitting portions of the stock on hand. (d) Using a constant price or nominal value for a so-called normal quantity of materials or goods in stock. (e) Including stock in transit, either shipped to or from the taxpayer, the title of which is not vested in the taxpayer. Art. 1583. 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 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. (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. . ., (b) miners and manufacturers who by a single process or uniform series of processes derive a product of two or more kinds, size or grade, the unit cost of which is substantially alike.. and retail merchants who use what is known as the "retail method" in ascertaining approximate cost. .... 9 Art. 1584. Inventories at Market.-Under ordinary circumstances and for normal goods in an inventory, "market" means the current bid price prevailing at the date of the inventory for the particular merchandise in the volume in which usually purchased by the taxpayer, and is applicable in the cases (a) of goods purchased and on hand, and (b) of basic elements of cost (materials, labor, and burden) in goods in process of manufacture and in finished goods on hand; exclusive, however, of goods on hand or in process of manufacture for delivery upon firm sales contracts (i. e., those not legally subject to cancellation by either party) at fixed prices entered into before the date of the inventory, which goods must be inventoried at cost. Where no open market exists or where quotations are nominal, due to stagnant market conditions, the taxpayer must use such evidence of a fair market price at the date or dates nearest the inventory as may be available, such as specific purchases or sales by the taxpayer or others in reasonable volume and made in good faith, or compensation paid for cancellation of contracts for purchase commitments. Where the taxpayer in the regular course of business has offered for sale such merchandise at prices lower than the current price as above defined, the inventory may be valued at such prices less proper allowance for selling expense, and the correctness of such prices will be determined by reference to the actual sales of the taxpayer for a reasonable period before and after the date of the inventory. Prices which vary materially from the actual prices so ascertained will not be accepted as reflecting the market. FACTS: PROBLEM 36 Illustrating Computation of "Net Loss" The statement of profit and loss of the Mohegan Oil Company, a West Virginia corporation, for the calendar year 1921, shows Net loss on the sale of capital assets and miscel laneous investments 30,000 $166,000 Loss for the year shown by books $110,000 Of the interest received, $1,500 is from 6% bonds of the City of Nashville and the entire amount of interest paid, $1,000, is on account of a loan secured to purchase and carry said bonds of the City of Nashville. The other $500 interest received was on |