APPEAL OF AMERICAN SEATING CO., Docket No. 4772.
| Decision Date | 31 July 1926 |
| Docket Number | Docket No. 4772. |
| Citation | 4 BTA 649 |
| Parties | APPEAL OF AMERICAN SEATING CO. |
| Court | U.S. Board of Tax Appeals |
Laurence Graves, Esq., and Norman A. Young, C. P. A., for the petitioner.
Thomas P. Dudley, Jr., Esq., for the Commissioner.
Before LITTLETON, SMITH, and TRUSSELL.
The taxpayer has petitioned for the redetermination of a deficiency in income and profits tax for the year 1920, asserted by the Commissioner to be in the amount of $33,892.60. Only such portion of the asserted deficiency is in controversy as results from alleged errors in the computation of invested capital, which alleged errors are as follows:
(1) That the Commissioner eliminated from invested capital the amount of $40,500, shown on taxpayer's books as the cost of certain inventions and application for patents relating to the use of steel tubing in the construction of school desks and seats.
(2) That the Commissioner eliminated from invested capital the sum of $198,712.37, a part of the claimed cost of developing the use of steel tubing in the manufacture of school seats and desks.
FINDINGS OF FACT.
The taxpayer is a corporation organized under the laws of the State of Illinois in the year 1906, and since that time has been continuously engaged in the business of manufacturing and selling desks, chairs, and seats for schools, churches, theatres, and other places of public assembly.
Prior to 1911 the framework of the desks and seats was made of cast iron manufactured at the taxpayer's foundry. As early as 1909 it was found that the cast iron frame did not stand up under the hard usage of the school; that it was subject to breakage both in use and in transit, resulting in considerable economic loss.
In 1909 it was decided to substitute a steel frame for the cast iron one then in use, and the taxpayer's engineers were put to work on the problem and continued on the experimental and development work during 1910, 1911, and 1912. The change from the use of the cast iron frame, which was comparatively simple to manufacture, to the steel frame was a radical departure from the methods of production then employed. It required not only additional buildings, machinery, and equipment, new dies, jigs, tools, and patents, but a complete change in the specifications of the remaining wooden parts, as well as a period of experiment and development during which the imperfections in the plans and specifications must be discovered and corrected and the machinery of operations by which quantity production was to be reached adjusted to meet such changes. This petitioner was the pioneer in the manufacture of the steel standard desk and therefore could not benefit by the experience of others.
In 1910 new buildings were constructed and machinery and equipment acquired and installed, following which the manufacture of the steel standard desk was started. There was some little production in 1910. Real production began in 1911. The period of transition from the cast iron frame to the steel frame continued through 1911 and 1912. During this entire transition period the petitioner kept an accurate and detailed record of the cost of changing from the cast iron to the steel frame, and such cost so recorded upon the taxpayer's books of account on December 31, 1912, amounted to the aggregate of $398,934.39. All of this aggregate was regularly charged on the books of the taxpayer as capital expenditures and none of it was ever charged to operating or other expenses.
When the petitioner entered upon and began the development of the use of steel frames, it opened up on its books of account a capital expenditure account under the designation of "steel construction." Into this account were charged many items of cost of material, labor, and superintendence. The transition from cast iron to steel frame resulted in many imperfections in plans, specifications, tools, dies, jigs, etc., with the natural result that a large part of the production of parts, and sometimes of completed desks and seats, were found to be not marketable and were junked, and this, of course, required the junking of all jigs, dies, etc., the making of new ones, and the production of new parts, entering into the construction of a completed and assembled marketable desk. Complete and accurate records of the cost of producing the steel standards were regularly kept from the beginning of the venture until the close of the year 1912. The steel construction account appearing on the company's ledger for the years 1911 and 1912 is summarized as follows:
Dr. Cr
1911 — January 1 Balance brought forward _______________ $96,446.87
33 items aggregating ____________________________ 37,707.08 $600.00
Oct. 26 St. Louis contracting acct. _____________ 33,239.77
Dec. 30 Steel operating loss ____________________ 55,296.55
__________
Debit balance ___________________________ 222,590.27
==========
1912 — January 1 Balance brought forward _______________ 222,590.27
40 items, aggregating ____________________ 66,164.09 118.00
Dec. 31 — Operating loss ________________________ 110,180.05
__________
Debit balance ___________________________ 398,934.39
In the foregoing, items of operating loss for the years 1911 and 1912, summarized from the petitioner's ledgers, are exhibited as follows:
During the years 1911 ...
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