SPRING CITY FOUNDRY COMPANY v. COMMISSIONER OF INTERNAL REVENUE
| Decision Date | 10 March 1932 |
| Docket Number | Docket No. 21169. |
| Citation | 25 BTA 822 |
| Parties | SPRING CITY FOUNDRY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
Richard H. Tyrrell, Esq., for the petitioner.
L. A. Luce, Esq., for the respondent.
This proceeding arises upon a determination by the respondent of a deficiency of $19,848.08 in petitioner's income and profits taxes for the calendar year 1920. The petitioner assigns two errors: (1) respondent's refusal to allow the deduction of a certain debt amounting to $39,983.27, which petitioner alleges it ascertained to be worthless and charged off in the taxable year under section 234(a) of the Revenue Act of 1918; and (2) the denial of petitioner's application to have its excess-profits taxes for that year assessed under sections 327 and 328 on the ground of abnormality.
FINDINGS OF FACT.
The petitioner, a corporation with its principal office at Waukesha, Wisconsin, was engaged in the manufacture of gray iron automobile castings. It sold castings to the Cotta Transmission Company, a manufacturer of automobile truck transmissions, of Rockford, Illinois, during the period from March, 1920, to September, 1920, inclusive, for which the latter company agreed to pay $40,302.07. Of this amount, $318.80 was paid or canceled by cash remittances or credit memoranda, leaving a balance of $39,983.27. The petitioner was accustomed to accept from the debtor, the Cotta Company, its promissory notes and to discount them at the bank. Five notes were given by the Cotta Company to the petitioner in 1920 as follows:
1. Dated April 1, 1920, 90 days, 6 per cent, $5,600.
2. Dated May 18, 1920, 90 days, $5,300.
3. Dated June 19, 1920, 90 days, 7 per cent, $5,100.
4. Dated July, 1920, 90 days, $9,300; discounted. When this note came due on October 13, 1920, and was not paid by the debtor, the petitioner gave its own note as maker on November 23, 1920, for 6 months, due May 21, 1921.
5. Dated August 16, 1920, 4 months, $6,990; discounted by petitioner with bank and paid by petitioner on December 21, 1920.
Three of these notes, for $5,600, $5,300, and $5,100, which had been renewed by the debtor from time to time, and had been discounted by petitioner with the bank, when falling due in December, 1920, were taken up by the petitioner, which gave the bank a new note for $16,000 for 6 months, dated December 28, 1920. This note and the note for $9,300 given by the petitioner to the bank were ultimately paid by the petitioner. The total sum of the principal of the notes unpaid by the debtor and paid to the bank in cash by petitioner or by its note in 1920 was $32,390. The notes were unsecured.
The balance due on the petitioner's open account with the debtor at the close of December, 1920, was $7,693.27. This amount was unsecured. Neither the notes claim nor the open account was protected by insurance.
The amount of the Cotta Company's indebtedness to the petitioner, on notes and open account, $39,983.27, was charged on the petitioner's books on December 28, 1920, to "Profit and Loss," in compliance with the directions of the petitioner's president, Blair, to charge off the debt as bad, after Blair had conferred with the secretary and manager of petitioner, Reichl, on the matter and after examination of debtor's plant and assets, as will be more fully shown later.
The Cotta Company, finding itself in financial straits in the latter part of 1920, requested of its principal creditors at a meeting on October 6, 1920, at Chicago, a five-year extension on all its accounts. This was refused. The creditors then appointed a creditors' committee to investigate the debtor's condition. The Eastern creditors met in Buffalo on the same day and the Rockford creditors met in Rockford on October 8. The petitioner was on the creditors' committee, which was to take charge of the debtor's business until December 15, 1920, a moratorium being declared in the interval. Shortly after the creditors' meeting of October 6, 1920, Blair, president and treasurer of petitioner, together with Reichl, its secretary and manager, went to Rockford to look into the debtor's condition. With them were representatives of other creditors. They looked over the debtor's plant, conferred with various persons, and decided to have an audit of the debtor's affairs made. The committee employed Arthur Young & Company, C. P. A.'s, to examine the debtor's condition and report. The report was made on October 25 as of October 15, 1920.
The Young audit showed the debtor's cash and cash investments at $1,639.73; its accounts receivable at $126,107.92, of which, accounts in the amount of $63,108.02 were hypothecated to secure bank loans and overdrafts; inventories at $509,680.36, $446,849 thereof being finished or partly finished transmission parts; promotion and development expense, patent rights, etc., at $195,724.90; plant assets at $425,714.91; additional real estate at $14,947.16; the last three items constituting total fixed assets at $636,386.97; and total assets at $1,275,397.18. On the liability side the audit showed due to creditors, on open account, acceptances and notes, $593,513.81; due to banks on unsecured notes, $122,000, and on secured loans, $32,208.06; and due to officers and miscellaneous, $64,681.70 and $4,617.20, respectively, making total current liabilities, $817,020.77. There was a mortgage on land adjoining factory of $1,200.
The following comment was made on the balance sheet of the audit under the heading "inventories":
From its cost records the Company had arrived at an estimate of inventory at August 31, 1920, but no later figure was available, owing to the abandonment of cost keeping after that date. The manner of handling the cost records makes it impossible at the present time to arrive at an accurate statement of inventory values without a physical inventory. In order, however, to present a complete statement for Balance Sheet purposes we made an estimate based on results of operations for the first eight months of 1920, taking into consideration actual purchases of material, productive labor and overhead expense, the physical inventory valuation of January 1 and the book inventory of August 31. These figures indicated a cost of sales for the eight months of approximately 108 per cent; assuming a similar cost for the remaining 45 days to October 15, we arrived at an amount of $507,080.36 as the probable value of finished goods, work in process, raw materials and scrap at the latter date. A physical inventory of the bar steel and scrap iron on hand (priced and extended by the company staff) indicated their value to be $54,456.14 and $5,775, respectively, the balance of $446,849.22 being set up as finished parts and work in process.
PROMOTION AND DEVELOPMENT EXPENSES, ETC. (Schedules II and III):
The items of engineering and advertising expenses prepaid are stated as they appear on the Company's books. Details of the manner in which these amounts were arrived at by the Company officials are shown in Schedules II and III. The valuation of patent rights is also the one shown by the books. We verified the amount of insurance premiums unexpired. The total value of fire insurance policies in effect at October 15, 1920 is $750,000, with additional amounts of $200,000 covering sprinkler leakage, use and occupancy, etc.
PLANT ASSETS AND NON-OPERATING PROPERTY (Schedule IV):
These items are stated at the values appearing in the books. We understand that these represent cost prices but have made no verification of this.
The audit took cost prices, but made no attempt to verify them, relying entirely on book values. No allowance was made for obsolete parts. On the whole it was a hasty examination, designed to show fully the liabilities and obligations of the company, but to report the assets at their face or going-concern value, which was easily ascertainable and might be qualified as the individual creditors should see fit. The ordinary accounting method as to inventory, to take cost or market value, whichever is lower; and as to fixed assets, cost less depreciation, was not applied in the Young audit because of the assumption made as to a constant relation of value to sale price regardless of possible decrease in value or obsolescence.
On November 4, 1920, certain Rockford citizens made offer to the creditors' committee to purchase the debtor's plant and other assets at an amount equal to 33 1/3 per cent of the creditors' claims, provided all the creditors should accept. On the creditors' declination of the offer, it was raised to 40 per cent, payable on or before December 15, 1920. Practically all the important creditors accepted, but the offerors found themselves unable to make the offer good by the agreed date, or within the week's extension allowed thereafter.
Three creditors, including the petitioner, then filed with the United States District Court for the Northern District of Illinois a petition in bankruptcy against the debtor, on December 23, 1920. On the following day the Central Trust Company of Illinois was appointed by the court receiver of the debtor in bankruptcy. On the 26th of December, Hummel, the manager of the receivership department of the receiver, went to Rockford and took possession of the bankrupt's property. He made his preliminary investigation in the first week of the receivership, but continued to work on the debtor's affairs for over a year. He discussed its affairs with its creditors.
The schedule of the debtor's assets and debts filed with the court showed debts in the total amount of $815,278.65 and assets of $1,078,427.55. Listed under assets were bills, promissory notes and securities in the amount of $39,995.88, and debts due on open accounts totaling $100,290.80. These two amounts represent quick assets.
The debtor's inventories, as revealed by the receiver's investigation, consisted of parts for the manufacture of transmissions,...
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