Case Name: Appeal of Owen-Ames-Kimball Co.
Court: United States Board of Tax Appeals
Jurisdiction: United States
Decision Date: 1926-12-23
Citations: 5 B.T.A. 921
Docket Number: Docket No. 1637
Parties: Appeal of Owen-Ames-Kimball Co.
Judges: 
Reporter: Reports of the United States Board of Tax Appeals
Volume: 5
Pages: 921–929

Head Matter:
Appeal of Owen-Ames-Kimball Co.
Docket No. 1637.
Promulgated December 23, 1926.
Harry Friedman, Esq., and J. Robert Sherrod, Esq., for the petitioner.
Ward Loveless, Esq., for the Commissioner.

Opinion:
OPINION.
Milliken:
The petitioner is engaged in building and construction work, principally under contracts. During the years involved in this appeal it was carrying on such work under approximately 83 contracts. The work under at least 13 of its contracts was begun in one taxable year and completed in another taxable year; and the income derived from these contracts, in each of the years in question, is the issue which we are called upon to decide.
Under the provisions of section 13 (d) of the Revenue Act of 1916, a taxpayer maintaining its books of account upon a basis other than that of actual receipts and disbursements, was permitted to make its return upon the basis upon which its accounts were kept, provided such basis clearly reflected its net income. Under the provisions of section 212 (b) of the Revenue Act of 1918, it was mandatory upon a taxpayer to compute its net income, for the year 1918, in accordance with the method of accounting regularly employed in keeping the books of account, if the method employed clearly reflected the net income. The petitioner filed returns for the years 1917 and 1918, in both of which it computed its net income in accordance with the method employed in keeping the books of account. The Commissioner made adjustments in the net income, as reported in the returns, disallowing certain deductions which he deemed to be unallowable and unreasonable in amount, which resulted in his determination of a deficiency in respect of both years. The petitioner does not dispute the correctness of the several adjustments made by the Commissioner. It contends, however, that any computation of net income, for the two years under consideration, based upon the method employed in keeping its books of account, must necessarily be erroneous, since the method employed did not clearly reflect its net income, and that the Commissioner erred in failing to determine the net income upon a basis which would clearly reflect what the net income was. The important question is then — Does the method employed in keeping the petitioner's books of account, during the years involved in this appeal, clearly reflect its net income? If not, the petitioner is entitled to have its net income recomputed upon a basis which will clearly reflect its net income and to a redetermination of its tax liability upon the net income so computed.
It can not be said that any definite method was employed in keeping the petitioner's books of account. Certain it is that the manner in which the books were kept did not conform either with the cash receipts and disbursements method or the accrual method of accounting, the two alternative methods provided by statute for keeping accounts and making returns of income. Appeal of Chatham & Phenix National Bank, 1 B. T. A. 460; Appeal of Henry Reubel, 1 B. T. A. 676; Appeal of B. B. Todd, Inc., 1 B. T. A. 762. All items of income and expense, other than income from long-term contracts, were entered upon petitioner's books and accounted for in accordance with the accrual method of accounting. Income from long-term contracts, an important and perhaps the chief item of income in the petitioner's business, was accounted for on petitioner's books in an entirely inconsistent manner. There existed no uniform practice as to the time and manner of accounting for income from that source. This income was accounted for at the caprice of the bookkeeper, at irregular periods, and in amounts which were not determined upon any definite or reasonable basis. At times the profit to be derived from long-term contracts was accounted for on the books when work was commenced. On other occasions it was taken up on the books of account during the progress of the work, but at times and in amounts that bore no relation thereto. And as a further variation, there were instances when the income was not accounted for until the completion of the work under contract. In the latter case, the accounting for that income was on the basis of actual receipts, notwithstanding that the expenses incident thereto were accounted for in a prior year and not deferred to be offset against the income. It is perhaps superfluous to say that it is a fundamental principle, in computing net income under the several income tax acts, that all items of income and expense shall be consistently accounted for on the same basis; and any method of accounting which fails to recognize and give effect to this principle will not clearly reflect net income. The facts as to the manner in which petitioner's books of account were kept, during the years involved in this appeal, are such that we are convinced that the method employed in keeping the accounts did not conform with either of the two alternative bases provided by statute, and did not clearly reflect petitioner's net income. It follows that any computation of net income based upon the method employed in keeping the accounts will not result in a correct determination of net income, to which the petitioner is entitled, and resort must be made to some other method.
The petitioner asks that the income from the 13 long-term contracts described in the findings of fact, for each of the years under consideration, be redetermined upon the accrual basis, that is, by treating the income as accruing during the progress of the work under the contracts and allocating the income to the years in which it was actually earned. If the income from long-term contracts is computed in such a manner, all items of income and expense will be consistently accounted for upon the accrual basis, which will clearly and correctly reflect petitioner's net income. But the Commissioner takes exception to this method of accounting for income derived from long-term contracts, on the ground that under most of these contracts the commissions or fees, representing the petitioner's profits, were not due and payable until completion and acceptance of the work and could not be considered as income prior to the time they became due and payable. Wo think the manner of accounting for income from long-term contracts on the basis contended for by the petitioner is proper under the accrual method of accounting. The accrual method of accounting requires that at the end of every accounting period all income which has been earned during the period must be accounted for as income accrued in that period, though perhaps not collected, because it is not due and will not be collected until some future date. It contemplates that the income shall be determined on the basis of a fair distribution between the periods during which the income accrues. Under such a system of accounting a taxpayer accrues income, it does not receive it. Appeal of Clarence Schock, 1 B. T. A. 528. Accounting for the income on the basis contended for by the petitioner, the income from long-term contracts is apportioned between the taxable years in the same ratio that the work completed in each year bears to the whole, thus accruing the income in the years in which it was actually earned. It conforms entirely with the accrual method of accounting and, as we have said before, the accrual method will clearly reflect the petitioner's net income.
Whether the so-called completed contract basis of accounting for income derived from long-term contracts is a proper basis for computing net income under the income tax acts is a question which it is not necessary for us to decide in disposing of the issue before us, and we express no opinion in respect thereof. Suffice it to say, that the petitioner's books of account were not maintained upon the completed contract basis, as the Commissioner contends.
The petitioner's net income for the years 1917 and 1918 should be computed in accordance with the accrual method of accounting, the income from long-term contracts being determined upon the basis that it accrued in the year in which it was earned according to the progress of the work, as evidenced by the expenditures under these contracts.
During the year 1918 the petitioner had a Government contract on which all work was stopped because of cancellation thereof on December 6, 1918. Owing to the inability of the United States Housing Corporation to determine certain adjustments in connection with the work which had been done, the profit could not be ascertained until some time in 1919. Pending the final determination of the profit from this contract, a lump sum of $82,000 was credited in 1918 to profit and loss for that year. When all adjustments and doubtful items had been settled in 1919, an additional amount of $14,061.91 was found to be due the petitioner. The petitioner contended that this item of $14,061.91 constituted income for the year 1918, and alleges error on the part of the Commissioner in failing to include the same in the net income of that year. The allegation of error is admitted by the Commissioner in his answer to the petition. The net income for the year 1918 should be increased by the sum of $14,061.91.
Judgment will he entered on 15 days' notice, under Bule 50.