Court Opinion

ID: 4499753
Source: CourtListenerOpinion
Date Created: 2020-01-23 18:16:36.109417+00
Date Added: 2024-06-11T08:00:30.944692
License: Public Domain

*405OPINION.
Phillips:
Petitioner does not question the adjustment of its invested capital which gave rise to the deficiency determined by the Commissioner. It contends that it has discovered accounting errors in its original return whereby its income was overstated .by $76,202.36.
The petitioner purchased the greater part of its goods in London on the basis of the pound sterling. From time to time it purchased sterling exchange with which to pay its London creditors. Purchases were entered in its purchase account and in accounts payable at the normal rate of exchange of the pound sterling, while payments were entered in the cash book and in accounts payable at the cost of exchange remitted. In this manner, over a period of three years, the accounts of the company were distorted. This was discovered by an accountant at the close of 1920 and entries were made to bring the books into a condition where they reflected the true situation. However, in carrying these entries into the profit and loss statement, no attempt was made to allocate the amounts to the *406years in which the distortions occurred, but the entire amount was charged into 1920 profit, thereby overstating the profit from the operations of that year.
To determine the proper method to be followed in computing income in such a situation as we have here, the transactions must be analyzed. The company purchases goods, the purchase price being payable in pounds sterling. It may pay for those goods at the time of purchase by buying sterling at the then prevailing rate, or it may choose to establish a credit and pay the account later. In any event, the cost of the goods must be arrived at by reducing sterling to dollars at the rate of exchange prevailing on the date of purchase. Appeal of Bernuth Lembcke Co., 1 B. T. A. 1051.
If the company, instead of making payment at that time, makes ’ the purchase on credit, it is investing or speculating in foreign exchange. It may derive a profit or sustain a loss on the exchange operation, but the cost of the goods to it is not affected by such profit or loss. We therefore conclude that the proper method of accounting is to include purchases in the accounts at the rate of exchange prevailing at the date of purchase and to account for any profit or loss in the payment therefor as a separate transaction. Such was our decision in Appeal of Bernuth Lembcke Co., supra, where exchange was first purchased and later used to purchase goods. We there held that upon the purchase of the goods a loss resulted from the investment in exchange and that the cost of the goods was the value of the exchange at the date the goods were purchased.
During !920 the petitioner’s total purchases in sterling were £133,434-5-1. It entered this amount in its purchases at $649,357.73, at the normal rate of exchange. Actual cost, at the exchange rate prevailing at the various dates of purchase, was $477,264.59. Purchases for 1920 were therefore originally overstated by $172,093.14, the difference between the amount entered as cost and that which should have been entered. The correcting entry made by the petitioner, $208,892.64, included errors for 1918 and 1919 as well as 1920. To the extent that it corrects errors of prior years this entry has no place in the computation of 1920 income. The cost of goods purchased in 1920, and consequently the income for 1920, has been overstated in this entry by $36,799.50, the difference between the correcting entry which was made and that which should have been made.
At the close of 1920 the petitioner’s accountant also adjusted the books to reflect the profit derived from trading in exchange and credited $28,831.53 to profit for 1920 on this account. This amount was returned as income for that year. It represents the accountant’s computation of the gain derived from exchange transactions in 1918, 1919, and 1920. So far as it includes gain derived from remittances *407made in 1918 and 1919 it has no place in the computation of 1920 income.
The gain realized in 1920 upon exchange transactions completed in that year by the remittance of sterling, as set forth in the findings of fact, was $19,947.12. Income for 1920 has therefore been overstated by $8,884.41, the difference between the gain reported as realized and that realized in fact.
It is the contention of the petitioner that the net income for the year can be reflected correctly only by converting balances of accounts payable in sterling at the end of each year into dollars at the rate of exchange prevailing at the end of each year, thus in effect making an inventory item of such accounts. This contention has already been decided adversely to the contentions of the petitioner in the Appeal of Roessel & Co., Ltd., 2 B. T. A. 1141, where it was held that gain or loss on investments or transactions in foreign exchange were to be reported in the year in which the transaction is completed by payment. The computation of the gain set out above has been made upon that basis.

Decision will be entered on ÍS0 days’ notice, wnder Rule 50.