93 T.C. 500 (1989), 9236-87, Wayne Bolt and Nut Co. v. C.I.R.
|Citation:||93 T.C. 500|
|Opinion Judge:||RUWE, JUDGE:|
|Party Name:||WAYNE BOLT AND NUT COMPANY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent|
|Attorney:||Robert F. Forrest, George J. Haddad, and Joseph F. Dillon, for the petitioner. Margaret A. Satko, for the respondent.|
|Case Date:||October 23, 1989|
|Court:||United States Tax Court|
P was engaged in the business of selling metal fasteners. Prior to fiscal year 1982, P determined opening and ending inventory using a perpetual book inventory record keeping system. P verified book inventory by taking a partial physical inventory. In fiscal year 1982, P determined both opening and ending inventory on the basis of a complete physical inventory that was completed several months after the close of the fiscal year. This physical inventory, after adjustments, indicated that opening inventory for fiscal year 1982 was ten times greater than ending inventory reflected in the books and as originally reported for the end of the prior fiscal year.
R determined that P's opening inventory for fiscal year 1982 was $268,681, based on original book inventory, rather than $2,640,114, based on P's complete physical inventory. R did not question the accuracy of P's ending inventory for fiscal year 1982 even though ending inventory was based on the same complete physical inventory. R also argues that P's revaluation of opening and ending inventory for fiscal year 1982 is a change in accounting method.
Held: Opening and ending inventory must be computed using the same method of accounting. P's method of determining both opening and ending inventory on the basis of a complete physical inventory for fiscal year 1982 constitutes a change in accounting method requiring an adjustment under sec. 481 FN1, I.R.C. 1954.
Respondent determined a deficiency of $1,091,362 in petitioner's Federal income tax for the taxable year ended February 28, 1982. The issues for decision are whether petitioner correctly valued its opening inventory and, if so, whether petitioner changed its method of accounting so as to require adjustments pursuant to section 481.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioner, a Michigan corporation, is engaged in the business of selling metal fasteners. Petitioner's principal place of business was in Detroit, Michigan when the petition was filed in this case.
Petitioner sells approximately 50,000 different types of bolts, nuts, and other fasteners. Petitioner sells standard fasteners, which are listed in a catalog published by the metal fastener industry and are items of general usage, and ‘ specialty items,‘ which are fasteners designed to fit the specific needs of a particular customer or for use in a particular product.
Petitioner files its Federal income tax returns on a fiscal year basis with its fiscal year ending February 28. Petitioner uses the accrual method of accounting and values its inventory at the ‘ lower of cost or market.‘
Petitioner's main warehouse, the Wayne Division, is located in Detroit, Michigan, and its second smaller warehouse, the Warren Division, is located in Warren, Michigan. Petitioner moved into the main warehouse in 1974. The main warehouse is an old building containing approximately 70,000 square feet of floor space. The building was constructed in 1928, and an addition was made to the rear of the building in 1960. The warehouse portion of the building is divided into eight bays, with an office across the front.
In the older portion of the main warehouse, fasteners were placed in cartons, containers, casks, and other boxes, and were stacked on wooden pallets on the floor or in large wooden and metal bins. In the other rooms, casks or boxes of fasteners were placed on pallets, and the pallets were
stacked on shelves six levels high. Petitioner's inventory was disorganized in that identical types of fasteners were stored. in different areas of the main warehouse. Inventory was often lost or misplaced.
Petitioner acquired large fasteners from its Giant Bolt and Nut Division. With the exception of those products manufactured by its Giant Bolt and Nut Division, all the fasteners acquired by petitioner were purchased. Petitioner purchased fasteners directly from a manufacturer or as part of ‘ odd lots‘ or surplus merchandise.
Since the date of its incorporation on April 3, 1959, petitioner has maintained a perpetual book inventory record keeping system which it utilizes to determine the amount of its inventory. An inventory card was prepared and maintained for each type of fastener petitioner purchased. There are approximately 70,000 inventory cards in either an active or inactive inventory file at petitioner's two warehouses. The inventory cards maintained in the inactive inventory file are for items which have been fully disposed of or items considered to be inactive. Petitioner does not destroy any of its inventory cards. The Wayne Division and the Warren Division maintain their own separate perpetual book inventory record keeping system in the same manner.
When petitioner purchased fasteners from a manufacturer, petitioner's procedure was to prepare an inventory card when it received an initial order from a manufacturer of a particular type of fastener, and to include on the inventory card description of the fastener, the name of the supplier, the quantity received, the date it was received, its cost, and its location in the warehouse. For repetitive orders of the same type of fastener, petitioner made additional entries on the same card showing the quantity received, its cost, and the name of the supplier.
When petitioner purchased fasteners as part of ‘ odd lots‘ or surplus merchandise, petitioner's procedure was to prepare ‘ breakdown sheets‘ indicating the type of merchandise, its size, condition, finish, the quantity, the location at which the merchandise was to be stored, and the price paid per pound for the merchandise. It could take petitioner as much as two years to examine and break down the surplus merchandise and to prepare breakdown sheets. Once breakdown
sheets were prepared, they were then to be forwarded to the office for the preparation of inventory cards.
When petitioner shipped merchandise to a customer, petitioner's procedure called for the shipping department to prepare a shipping document containing a description of the fastener and the quantity shipped. The shipping document was to be sent to the office so that an entry could be made on the inventory card indicating the quantity shipped, the balance remaining, and the location of the unshipped items. After an order was filled in the shipping department, the box or keg from which the items were taken was not necessarily returned to the original location as noted on the inventory card.
Purchases and sales were not always recorded accurately or promptly on the inventory cards. In some instances, the inventory cards reflected quantity on hand but not cost. Inventory cards were not prepared for all items.
Each year prior to 1982, petitioner's General Manager, Joseph Luranc, verified inventory by randomly selecting approximately 300 of its 70,000 inventory cards and comparing the quantity listed on the...
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