Inventory accounting for tax purposes is governed by §§ 446 and
471 of the Internal Revenue Code of 1954. Section 446 provides that
taxable income is to be computed under the taxpayer's normal method
of accounting unless that method "does not clearly reflect income,"
in which event taxable income is to be computed "under such method
as, in the opinion of the [Commissioner], does clearly reflect
income." Section 471 provides that
"[w]henever in the opinion of the [Commissioner] the use of
inventories is necessary in order clearly to determine the income
of any taxpayer, inventory shall be taken by such taxpayer on such
basis as the [Commissioner] may prescribe as conforming as nearly
as may be to the best accounting practice in the trade or business
and as most clearly reflecting income."
The implementing Regulations require a taxpayer to value
inventory for tax purposes at cost unless "market" (defined as
replacement cost) is lower. The Regulations specify two situations
in which inventory may be valued below "market" as so defined: (1)
where the taxpayer in the normal course of business has actually
offered merchandise for sale at prices lower than replacement cost;
and (2) where the merchandise is defective. In 1964, petitioner, a
tool manufacturer, wrote down in accord with "generally accepted
accounting principles" what it regarded as "excess" inventory to
its own estimate of the "net realizable value" (generally scrap
value) of the "excess" goods (mostly spare parts), but continued to
hold the goods for sale at their original prices. It offset the
write-down against 1964 sales, and thereby produced a net operating
loss for that year. The Commissioner disallowed the offset,
maintaining that the writedown did not reflect income clearly for
tax purposes. Deductions for bad debts are covered by § 166.
Section 166(c) provides that an accrual-basis taxpayer "shall be
allowed (in the discretion of the [Commissioner]) a deduction for a
reasonable addition to a reserve for bad debts." In 1965,
petitioner added to its reserve and asserted as a deduction under §
166(c) a sum that presupposed a substantially higher charge-off
rate for bad debts than it had experienced in immediately preceding
years. The Commissioner ruled that the addition was excessive,
Page 439 U. S. 523
and determined, pursuant to the "six-year moving average"
formula derived from
Black Motor Co. v. Commissioner, 41
B.T.A. 300, what he regarded as a lesser but "reasonable" amount to
be added to petitioner's reserve. On petitioner's petition for
redetermination, the Tax Court upheld the Commissioner's exercise
of discretion with respect to both the inventory write-down and the
bad debt deduction, and the Court of Appeals affirmed.
Held:
1. The Commissioner did not abuse his discretion in determining
that the write-down of "excess" inventory failed to reflect
petitioner's 1964 income clearly, since the write-down was plainly
inconsistent with the governing Regulations. Pp.
439 U. S.
531-546.
(a) Although conceding that "an active market prevailed" on the
inventory date, petitioner made no effort to determine the
replacement cost of its "excess" inventory, and thus failed to
ascertain "market" in accord with the general rule of the
Regulations. Petitioner, however, failed to bring itself within
either of the authorized exceptions for valuing inventory below
"market." Whereas the Regulations demand concrete evidence of
reduced market value, petitioner provided no objective evidence
whatever that its "excess" inventory had the value management
ascribed to it. Pp.
439 U. S.
535-538.
(b) There is no presumption that an inventory practice
conformable to "generally accepted accounting principles" is valid
for tax purposes. Such a presumption is insupportable m light of
the statute, this Court's past decisions, and the differing
objectives of tax and financial accounting. Pp.
439 U. S.
538-544.
(c) While petitioner argues that it should not be forced to
defer a tax benefit for inventory currently deemed unsalable until
future years, when the "excess" items are actually disposed of,
petitioner's "dilemma" is nothing more than the choice every
taxpayer with a paper loss must face. Pp.
439 U. S.
545-546.
2. The Commissioner did not abuse his discretion in recomputing
a "reasonable" addition to petitioner's bad debt reserve according
to the
Black Motor formula. Because petitioner did not
show why its debt collections in 1965 would be less likely than in
prior years, it failed to carry its "heavy burden" of showing that
application of the
Black Motor formula would have been
arbitrary. Pp.
439 U. S.
546-550
563 F.2d 861, affirmed.
BLACKMUN, J., delivered the opinion for a unanimous Court.
Page 439 U. S. 524
MR. JUSTICE BLACKMUN delivered the opinion of the Court.
This case, as it comes to us, presents two federal income tax
issues. One has to do with inventory accounting. The other relates
to a bad debt reserve.
The Inventory Issue. In 1964, petitioner Thor Power
Tool Co. (hereinafter sometimes referred to as the taxpayer), in
accord with "generally accepted accounting principles," wrote down
what it regarded as excess inventory to Thor's own estimate of the
net realizable value of the excess goods. Despite this write-down,
Thor continued to hold the goods for sale at original prices. It
offset the write-down against 1964 sales, and thereby produced a
net operating loss for that year; it then asserted that loss as a
carryback to 1963 under § 172 of the Internal Revenue Code of 1954,
26 U.S.C. § 172. The Commissioner of Internal Revenue, maintaining
that the write-down did not serve to reflect income clearly for tax
purposes, disallowed the offset and the carryback.
The Bad-Debt Issue. In 1965, the taxpayer added to its
reserve for bad debts and asserted as a deduction, under § 166(c)
of the Code, 26 U.S.C. § 166(c), a sum that presupposed a
substantially higher charge-off rate than Thor had experienced in
immediately preceding years. The Commissioner ruled that the
addition was excessive, and determined, pursuant to a formula based
on the taxpayer's past experience,
Page 439 U. S. 525
what he regarded as a lesser but "reasonable" amount to be added
to Thor's reserve.
On the taxpayer's petition for redetermination, the Tax Court,
in an unreviewed decision by Judge Goffe, upheld the Commissioner's
exercise of discretion in both respects. 64 T.C. 154 (1975). As a
consequence, and also because of other adjustments not at issue
here, the court redetermined, App. 264, the following deficiencies
in Thor's federal income tax:
calendar year 1963 -- $494,055.99
calendar year 1965 -- $ 59,287.48
The United States Court of Appeals for the Seventh Circuit
affirmed. 563 F.2d 861 (1977). We granted certiorari, 435 U.S. 914
(1978), to consider these important and recurring income tax
accounting issues.
I
The Inventory Issue
A
Taxpayer is a Delaware corporation with principal place of
business in Illinois. It manufactures hand-held power tools, parts
and accessories, and rubber products. At its various plants and
service branches, Thor maintains inventories of raw materials,
work-in-process, finished parts and accessories, and completed
tools. At all times relevant, Thor has used, both for financial
accounting and for income tax purposes, the "lower of cost or
market" method of valuing inventories. App. 23-24.
See
Treas.Reg. § 1.471-2(c), 26 CFR § 1.471-2(c) (1978).
Thor's tools typically contain from 50 to 200 parts, each of
which taxpayer stocks to meet demand for replacements. Because of
the difficulty, at the time of manufacture, of predicting the
future demand for various parts, taxpayer produced liberal
quantities of each part to avoid subsequent production
Page 439 U. S. 526
runs. Additional runs entail costly retooling and result in
delays in filling orders. App. 54-55.
In 1960, Thor instituted a procedure for writing down the
inventory value of replacement parts and accessories for tool
models it no longer produced. It created an inventory
contra-account and credited that account with 10% of each part's
cost for each year since production of the parent model had ceased.
64 T.C. at 156-157; App. 24. The effect of the procedure was to
amortize the cost of these parts over a 10-year period. For the
first nine months of 1964, this produced a write-down of $22,090.
64 T.C. at 157; App. 24.
In late 1964, new management took control and promptly concluded
that Thor's inventory in general was overvalued. [
Footnote 1] After "a physical inventory taken
at all locations" of the tool and rubber divisions,
id. at
52, management wrote off approximately $2.75 million of obsolete
parts, damaged or defective tools, demonstration or sales samples,
and similar items.
Id. at 52-53. The Commissioner allowed
this writeoff because Thor scrapped most of the articles shortly
after their removal from the 1964 closing inventory. [
Footnote 2] Management also wrote down
$245,000 of parts stocked for three unsuccessful products.
Page 439 U. S. 527
Id. at 56. The Commissioner allowed this write-down,
too, since Thor sold these items at reduced prices shortly after
the close of 1964.
Id. at 62.
This left some 44,000 assorted items, the status of which is the
inventory issue here. Management concluded that many of these
articles, mostly spare parts, [
Footnote 3] were "excess" inventory, that is, that they
were held in excess of any reasonably foreseeable future demand. It
was decided that this inventory should be written down to its "net
realizable value," which, in most cases, was scrap value. 64 T.C.
at 160-161; Brief for Petitioner 9; Tr. of Oral Arg. 11.
Two methods were used to ascertain the quantity of excess
inventory. Where accurate data were available, Thor forecast future
demand for each item on the basis of actual 1964 usage, that is,
actual sales for tools and service parts, and actual usage for raw
materials, work-in-process, and production parts. Management
assumed that future demand for each item would be the same as it
was in 1964. Thor then applied the following aging schedule: the
quantity of each item corresponding to less than one year's
estimated demand was kept at cost; the quantity of each item in
excess of two years' estimated demand was written off entirely; and
the quantity of each item corresponding to from one to two years'
estimated demand was written down by 50% or 75%. App. 26. [
Footnote 4] Thor presented no
statistical evidence to rationalize
Page 439 U. S. 528
these percentages or this timeframe. In the Tax Court, Thor's
president justified the formula by citing general business
experience, and opined that it was "somewhat in between" possible
alternative solutions. [
Footnote
5] This first method yielded a total write-down of $744,030. 64
T C., at 160.
Page 439 U. S. 529
At two plants where 1964 data were inadequate to permit
forecasts of future demand, Thor used its second method for valuing
inventories. At these plants, the company employed flat percentage
write-downs of 5%, 10%, and 50% for various types of inventory.
[
Footnote 6] Thor presented no
sales or other data to support these percentages. Its president
observed that "this is not a precise way of doing it," but said
that the company
"felt some adjustment of this nature was in order, and these
figures represented our best estimate of what was required to
reduce the inventory to net realizable value."
App. 67. This second method yielded a total write-down of
$160,832. 64 T.C. at 160.
Although Thor wrote down all its "excess" inventory at once, it
did not immediately scrap the articles or sell them at reduced
prices, as it had done with the $3 million of obsolete and damaged
inventory, the write-down of which the Commissioner permitted.
Rather, Thor retained the "excess" items physically in inventory
and continued to sell them at original prices.
Id. at
160-161. The company found that, owing to the peculiar nature of
the articles involved, [
Footnote
7] price reductions were of no avail in moving this "excess"
inventory.
Page 439 U. S. 530
As time went on, however, Thor gradually disposed of some of
these items as scrap; the record is unclear as to when these
dispositions took place. [
Footnote
8]
Thor's total write-down of "excess" inventory in 1964 therefore
was:
Ten-year amortization of parts for
discontinued tools $22,090
First method (aging formula based
on 1964 usage) 744,030
Second method (flat percentage
write-downs) 160,832
--------
Total $926,952
Thor credited this sum to its inventory contra-account, thereby
decreasing closing inventory, increasing cost of goods sold, and
decreasing taxable income for the year by that amount. [
Footnote 9] The company contended that,
by writing down excess inventory to scrap value, and by thus
carrying all inventory at "net realizable value," it had reduced
its inventory to "market" in accord with its "lower of cost or
market" method of accounting. On audit, the Commissioner disallowed
the write-down in its entirety, asserting that it did not serve
clearly to reflect Thor's 1964 income for tax purposes.
The Tax Court, in upholding the Commissioner's determination,
found as a fact that Thor's write-down of excess inventory did
conform to "generally accepted accounting principles"; indeed, the
court was "thoroughly convinced . . . that such was the case."
Id. at 165. The court found that, if Thor had failed to
write down its inventory on some reasonable
Page 439 U. S. 531
basis, its accountants would have been unable to give its
financial statements the desired certification.
Id. at
161-162. The court held, however, that conformance with "generally
accepted accounting principles" is not enough; § 446(b), and § 471
as well, of the 1954 Code, 26 U.S.C. §§ 446(b) and 471, prescribe,
as an independent requirement, that inventory accounting methods
must "clearly reflect income." The Tax Court rejected Thor's
argument that its write-down of "excess" inventory was authorized
by Treasury Regulations, 64 T.C. at 167-171, and held that the
Commissioner had not abused his discretion in determining that the
write-down failed to reflect 1964 income clearly.
B
Inventory accounting is governed by §§ 446 and 471 of the Code,
26 U.S.C. §§ 446 and 471. Section 446(a) states the general rule
for methods of accounting:
"Taxable income shall be computed under the method of accounting
on the basis of which the taxpayer regularly computes his income in
keeping his books."
Section 446(b) provides, however, that, if the method used by
the taxpayer
"does not clearly reflect income, the computation of taxable
income shall be made under such method as, in the opinion of the
[Commissioner], does clearly reflect income."
Regulations promulgated under § 446, and in effect for the
taxable year 1964, state that "no method of accounting is
acceptable unless, in the opinion of the Commissioner, it clearly
reflects income." Treas.Reg. § 1.446-1(a)(2), 26 CFR §
1.446-1(a)(2) (1964). [
Footnote
10]
Section 471 prescribes the general rule for inventories. It
states:
"Whenever in the opinion of the [Commissioner] the use
Page 439 U. S. 532
of inventories is necessary in order clearly to determine the
income of any taxpayer, inventory shall be taken by such taxpayer
on such basis as the [Commissioner] may prescribe as conforming as
nearly as may be to the best accounting practice in the trade or
business and as most clearly reflecting the income."
As the Regulations point out, § 471 obviously establishes two
distinct tests to which an inventory must conform. First, it must
conform "as nearly as may be" to the "best accounting practice," a
phrase that is synonymous with "generally accepted accounting
principles." Second, it "must clearly reflect the income."
Treas.Reg. § 1.471-2(a)(2), 26 CFR § 1.471-2(a)(2) (1964).
It is obvious that, on their face, §§ 446 and 471, with their
accompanying Regulations, vest the Commissioner with wide
discretion in determining whether a particular method of inventory
accounting should be disallowed as not clearly reflective of
income. This Court's cases confirm the breadth of this discretion.
In construing § 446 and its predecessors, the Court has held that
"[t]he Commissioner has broad powers in determining whether
accounting methods used by a taxpayer clearly reflect income."
Commissioner v. Hansen, 360 U. S. 446,
360 U. S. 467
(1959). Since the Commissioner has "[m]uch latitude for
discretion," his interpretation of the statute's clear reflection
standard "should not be interfered with unless clearly unlawful."
Lucas v. American Code Co., 280 U.
S. 445,
280 U. S. 449
(1930). To the same effect are
United States v. Catto,
384 U. S. 102,
384 U. S. 114
(1966);
Schlude v. Commissioner, 372 U.
S. 128,
372 U. S.
133-134 (1963);
American Automobile Assn. v. United
States, 367 U. S. 687,
367 U. S.
697-698 (1961);
Automobile Club of Michigan v.
Commissioner, 353 U. S. 180,
353 U. S.
189-190 (1957);
Brown v. Helvering,
291 U. S. 193,
291 U. S. 203
(1934). In construing § 203 of the Revenue Act of 1918, 40 Stat.
1060, a predecessor of § 471, the Court held that the taxpayer
bears a "heavy burden of [proof] ," and that the Commissioner's
disallowance
Page 439 U. S. 533
of an inventory accounting method is not to be set aside unless
shown to be "plainly arbitrary."
Lucas v. Structural Steel
Co., 281 U. S. 264,
281 U. S. 271
(1930).
As has been noted, the Tax Court found as a fact in this case
that Thor's write-down of "excess" inventory conformed to
"generally accepted accounting principles," and was "within the
term,
best accounting practice,' as that term is used in
section 471 of the Code and the regulations promulgated under that
section." 64 T.C. at 161, 165. Since the Commissioner has not
challenged this finding, there is no dispute that Thor satisfied
the first part of § 471's two-pronged test. The only question,
then, is whether the Commissioner abused his discretion in
determining that the write-down did not satisfy the test's second
prong in that it failed to reflect Thor's 1964 income clearly.
Although the Commissioner's discretion is not unbridled and may not
be arbitrary, we sustain his exercise of discretion here, for, in
this case, the write-down was plainly inconsistent with the
governing Regulations which the taxpayer, on its part, has not
challenged. [Footnote
11]
It has been noted above that Thor at all pertinent times used
the "lower of cost or market" method of inventory accounting. The
rules governing this method are set out in Treas.Reg.
Page 439 U. S. 534
§ 1.471; 26 CFR § 1.471 (1964). That Regulation defines "market"
to mean, ordinarily,
"the current bid price prevailing at the date of the inventory
for the particular merchandise in the volume in which usually
purchased by the taxpayer."
§ 1.471(a). The court have uniformly interpreted "bid price" to
mean replacement cost, that is, the price the taxpayer would have
to pay on the open market to purchase or reproduce the inventory
items. [
Footnote 12] Where
no open market exists, the Regulations require the taxpayer to
ascertain "bid price" by using
"such evidence of a fair market price at the date or dates
nearest the inventory as may be available, such as specific
purchases or sales by the taxpayer or others in reasonable volume
and made in good faith, or compensation paid for cancellation of
contracts for purchase commitments."
§ 1.471(b).
The Regulations specify two situations in which a taxpayer is
permitted to value inventory below "market" as so defined. The
first is where the taxpayer in the normal course of business has
actually offered merchandise for sale at prices lower than
replacement cost. Inventories of such merchandise may be valued at
those prices less direct cost of disposition,
"and the correctness of such prices will be determined by
reference to the actual sales of the taxpayer for a reasonable
period before and after the date of the inventory."
Ibid. The Regulations warn that prices "which vary
materially from the
Page 439 U. S. 535
actual prices so ascertained will not be accepted as reflecting
the market."
Ibid.
The second situation in which a taxpayer may value inventory
below replacement cost is where the merchandise itself is
defective. If goods are
"unsalable at normal prices or unusable in the normal way
because of damage, imperfections, shop wear, changes of style, odd
or broken lots, or other similar causes,"
the taxpayer is permitted to value the goods "at bona fide
selling prices less direct cost of disposition." § 1.471-2(c). The
Regulations define "bona fide selling price" to mean an "actual
offering of goods during a period ending not later than 30 days
after inventory date."
Ibid. The taxpayer bears the burden
of proving that "such exceptional goods as are valued upon such
selling basis come within the classifications indicated," and is
required to "maintain such records of the disposition of the goods
as will enable a verification of the inventory to be made."
Ibid.
From this language, the regulatory scheme is clear. The taxpayer
must value inventory for tax purposes at cost unless the "market"
is lower. "Market" is defined as "replacement cost," and the
taxpayer is permitted to depart from replacement cost only in
specified situations. When it makes any such departure, the
taxpayer must substantiate its lower inventory valuation by
providing evidence of actual offerings, actual sales, or actual
contract cancellations. In the absence of objective evidence of
this kind, a taxpayer's assertions as to the "market value" of its
inventory are not cognizable in computing its income tax.
It is clear to us that Thor's procedures for writing down the
value of its "excess" inventory were inconsistent with this
regulatory scheme. Although Thor conceded that "an active market
prevailed" on the inventory date,
see 64 T.C. at 169, it
"made no effort to determine the purchase or reproduction cost" of
its "excess" inventory.
Id. at 162. Thor thus failed to
ascertain "market" in accord with the general rule of the
Page 439 U. S. 536
Regulations. In seeking to depart from replacement cost, Thor
failed to bring itself within either of the authorized exceptions.
Thor is not able to take advantage of § 1.471-4(b), since, as the
Tax Court found, the company failed to sell its excess inventory or
offer it for sale at prices below replacement cost. 64 T.C. at
160-161. Indeed, Thor concedes that it continued to sell its
"excess" inventory at original prices. Thor also is not able to
take advantage of § 1.471-2(c) since, as the Tax Court and the
Court of Appeals both held, it failed to bear the burden of proving
that its excess inventory came within the specified
classifications. 64 T.C. at 171; 563 F.2d at 867. Actually, Thor's
"excess" inventory was normal and unexceptional, and was
indistinguishable from and intermingled with the inventory that was
not written down.
More importantly, Thor failed to provide any objective evidence
whatever that the "excess" inventory had the "market value"
management ascribed to it. The Regulations demand hard evidence of
actual sales, and further demand that records of actual
dispositions be kept. The Tax Court found, however, that Thor made
no sales and kept no records. 64 T.C. at 171. Thor's management
simply wrote down its closing inventory on the basis of a well
educated guess that some of it would never be sold. The formulae
governing this writedown were derived from management's collective
"business experience"; the percentages contained in those formulae
seemingly were chosen for no reason other than that they were
multiples of five and embodied some kind of anagogical symmetry.
The Regulations do not permit this kind of evidence. If a taxpayer
could write down its inventories on the basis of management's
subjective estimates of the goods' ultimate salability, the
taxpayer would be able, as the Tax Court observed,
id. at
170, "to determine how much tax it wanted to pay for a given year."
[
Footnote 13]
Page 439 U. S. 537
For these reasons, we agree with the Tax Court and with the
Seventh Circuit that the Commissioner acted within his discretion
in deciding that Thor's write-down of "excess"
Page 439 U. S. 538
inventory failed to reflect income clearly. In the light of the
well known potential for tax avoidance that is inherent in
inventory accounting, [
Footnote
14] the Commissioner, in his discretion, may insist on a high
evidentiary standard before allowing write-downs of inventory to
"market." Because Thor provided no objective evidence of the
reduced market value of its "excess" inventory, its write-down was
plainly inconsistent with the Regulations, and the Commissioner
properly disallowed it. [
Footnote 15]
C
The taxpayer's major argument against this conclusion is based
on the Tax Court's clear finding that the write-down conformed to
"generally accepted accounting principles." Thor points to language
in Treas.Reg. § 1.446-1(a)(2), 26 FR § 1.446-1(a)(2) (1964), to the
effect that
"[a] method of accounting which reflects the consistent
application of generally
Page 439 U. S. 539
accepted accounting principles . . .
will ordinarily be
regarded as clearly reflecting income."
(Emphasis added.) Section 1.471-2(b), 26 CFR § 1.471-2(b)
(1964), of the Regulations likewise stated that an inventory taken
in conformity with best accounting practice "can,
as a general
rule, be regarded as clearly reflecting . . . income"
(emphasis added). [
Footnote
16] These provisions, Thor contends, created a
presumption that an inventory practice conformable to
"generally accepted accounting principles" is valid for income tax
purposes. Once a taxpayer has established this conformity, the
argument runs, the burden shifts to the Commissioner affirmatively
to demonstrate that the taxpayer's method does not reflect income
clearly. Unless the Commissioner can show that a generally accepted
method "demonstrably distorts income," Brief for Chamber of
Commerce of the United States
Page 439 U. S. 540
as
Amicus Curiae 3, or that the taxpayer's adoption of
such method was "motivated by tax avoidance," Brief for Petitioner
25, the presumption in the taxpayer's favor will carry the day. The
Commissioner, Thor concludes, failed to rebut that presumption
here.
If the Code and Regulations did embody the presumption
petitioner postulates, it would be of little use to the taxpayer in
this case. As we have noted, Thor's write-down of "excess"
inventory was inconsistent with the Regulations; any general
presumption obviously must yield in the face of such particular
inconsistency. We believe, however, that no such presumption is
present. Its existence is insupportable in light of the statute,
the Court's past decisions, and the differing objectives of tax and
financial accounting.
First, as has been stated above, the Code and Regulations
establish two distinct tests to which an inventory must conform.
The Code and Regulations, moreover, leave little doubt as to which
test is paramount. While § 471 of the Code requires only that an
accounting practice conform "as nearly as may be" to best
accounting practice, § 1.441(a)(2) of the Regulations states
categorically that "
no method of accounting is acceptable
unless, in the opinion of the Commissioner, it clearly reflects
income" (emphasis added). Most importantly, the Code and
Regulations give the Commissioner broad discretion to set aside the
taxpayer's method if, "in [his] opinion," it does not reflect
income clearly. This language is completely at odds with the notion
of a "presumption" in the taxpayer's favor. The Regulations embody
no presumption; they say merely that, in most cases, generally
accepted accounting practices will pass muster for tax purposes.
And in most cases they will. But if the Commissioner, in the
exercise of his discretion, determines that they do not, he may
prescribe a different practice without having to rebut any
presumption running against the Treasury.
Page 439 U. S. 541
Second, the presumption petitioner postulates finds no support
in this Court's prior decisions. It was early noted that the
general rule specifying use of the taxpayer's method of accounting
"is expressly limited to cases where the Commissioner believes that
the accounts clearly reflect the net income."
Lucas v. American
Code Co., 280 U.S. at
280 U. S. 449. More recently, it was held in
American Automobile Assn. v. United States that a taxpayer
must recognize prepaid income when received, even though this would
mismatch expenses and revenues in contravention of "generally
accepted commercial accounting principles." 367 U.S. at
367 U. S.
690.
"[T]o say that, in performing the function of business
accounting, the method employed by the Association 'is in accord
with generally accepted commercial accounting principles and
practices,'"
the Court concluded, "is not to hold that, for income tax
purposes, it so clearly reflects income as to be binding on the
Treasury."
Id. at
367 U. S. 693.
"[W]e are mindful that the characterization of a transaction for
financial accounting purposes, on the one hand, and for tax
purposes, on the other, need not necessarily be the same."
Frank Lyon Co. v. United States, 435 U.
S. 561,
435 U. S. 577
(1978).
See Commissioner v. Idaho Power Co., 418 U. S.
1,
418 U. S. 15
(1974). Indeed, the Court's cases demonstrate that divergence
between tax and financial accounting is especially common when a
taxpayer seeks a current deduction for estimated future expenses or
losses.
E.g., Commissioner v. Hansen, 360 U.
S. 446 (1959) (reserve to cover contingent liability in
event of nonperformance of guarantee);
Brown v. Helvering,
291 U. S. 193
(1934) (reserve to cover expected liability for unearned
commissions on anticipated insurance policy cancellations);
Lucas v. American Code Co., supra, (reserve to cover
expected liability on contested lawsuit). The rationale of these
cases amply encompasses Thor's aim. By its president's concession,
the company's write-down of "excess" inventory was founded on the
belief that many of the articles inevitably would become
useless
Page 439 U. S. 542
due to breakage, technological change, fluctuations in market
demand, and the like. [
Footnote
17] Thor, in other words, sought a current "deduction" for an
estimated future loss. Under the decided cases, a taxpayer so
circumstanced finds no shelter beneath an accountancy
presumption.
Third, the presumption petitioner postulates is insupportable in
light of the vastly different objectives that financial and tax
accounting have. The primary goal of financial accounting is to
provide useful information to management, shareholders, creditors,
and others properly interested; the major responsibility of the
accountant is to protect these parties from being misled. The
primary goal of the income tax system, in contrast, is the
equitable collection of revenue; the major responsibility of the
Internal Revenue Service is to protect the public fisc.
Consistently with its goals and responsibilities, financial
accounting has as its foundation the principle of conservatism,
with its corollary that "possible errors in measurement [should] be
in the direction of understatement, rather than overstatement, of
net income and net assets." [
Footnote 18] In view of the Treasury's markedly different
goals and responsibilities, understatement of income is not
destined to be its guiding light. Given this diversity, even
contrariety,
Page 439 U. S. 543
of objectives, any presumptive equivalency between tax and
financial accounting would be unacceptable. [
Footnote 19]
This difference in objectives is mirrored in numerous
differences of treatment. Where the tax law requires that a
deduction be deferred until "all the events" have occurred that
will make it fixed and certain,
United States v. Anderson,
269 U. S. 422,
269 U. S. 441
(1926), accounting principles typically require that a liability be
accrued as soon as it can reasonably be estimated. [
Footnote 20] Conversely, where the tax law
requires that income be recognized currently under "claim of
right," "ability to pay," and "control" rationales, accounting
principles may defer accrual until a later year, so that revenues
and expenses may be better matched. [
Footnote 21] Financial accounting, in short, is
hospitable to estimates, probabilities, and reasonable certainties;
the tax law, with its mandate to preserve the revenue, can give no
quarter to uncertainty. This is as it should be. Reasonable
estimates may be useful, even essential, in giving shareholders and
creditors an accurate picture of a firm's overall financial health,
but the accountant's conservatism cannot bind the Commissioner in
his efforts to collect taxes. "Only a few reserves voluntarily
established as a matter
Page 439 U. S. 544
of conservative accounting," Mr. Justice Brandeis wrote for the
Court, "are authorized by the Revenue Acts."
Brown v.
Helvering, 291 U.S. at
219 U. S.
201-202.
Finally, a presumptive equivalency between tax and financial
accounting would create insurmountable difficulties of tax
administration. Accountants long have recognized that "generally
accepted accounting principles" are far from being a canonical set
of rules that will ensure identical accounting treatment of
identical transactions. [
Footnote 22] "Generally accepted accounting principles,"
rather, tolerate a range of "reasonable" treatments, leaving the
choice among alternatives to management. Such, indeed, is precisely
the case here. [
Footnote 23]
Variances of this sort may be tolerable in financial reporting, but
they are questionable in a tax system designed to ensure, as far as
possible, that similarly situated taxpayers pay the same tax. If
management's election among "acceptable" options were dispositive
for tax purposes, a firm, indeed, could decide unilaterally --
within limits dictated only by its accountants -- the tax it wished
to pay. Such unilateral decisions would not just make the Code
inequitable; they would make it unenforceable.
Page 439 U. S. 545
D
Thor complains that a decision adverse to it poses a dilemma.
According to the taxpayer, it would be virtually impossible for it
to offer objective evidence of its "excess" inventory's lower
value, since the goods cannot be sold at reduced prices; even if
they could be sold, says Thor, their reduced-price sale would just
"pull the rug out" from under the identical "non-excess" inventory
Thor is trying to sell simultaneously. The only way Thor could
establish the inventory's value by a "closed transaction" would be
to scrap the articles at once. Yet immediate scrapping would be
undesirable, for demand for the parts ultimately might prove
greater than anticipated. The taxpayer thus sees itself presented
with
"an unattractive Hobson's choice: either the unsalable inventory
must be carried for years at its cost instead of net realizable
value, thereby overstating taxable income by such overvaluation
until it is scrapped, or the excess inventory must be scrapped
prematurely, to the detriment of the manufacturer and its
customers."
Brief for Petitioner 25.
If this is indeed the dilemma that confronts Thor, it is in
reality the same choice that every taxpayer who has a paper loss
must face. It can realize its loss now and garner its tax benefit,
or it can defer realization, and its deduction, hoping for better
luck later. Thor, quite simply, has suffered no present loss. It
deliberately manufactured its "excess" spare parts because it
judged that the marginal cost of unsalable inventory would be lower
than the cost of retooling machinery should demand surpass
expectations. This was a rational business judgment and, not
unpredictably, Thor now has inventory it believes it cannot sell.
Thor, of course, is not so confident of its prediction as to be
willing to scrap the "excess" parts now; it wants to keep them on
hand, just in case. This, too, is a rational judgment, but there is
no reason why the Treasury should subsidize Thor's hedging of its
bets. There
Page 439 U. S. 546
is also no reason why Thor should be entitled, for tax purposes,
to have its cake and to eat it too.
II
The Bad-Debt Issue
A
Deductions for bad debts are covered by § 166 of the 1954 Code,
26 U.S.C. § 166. Section 166(a)(1) sets forth the general rule that
a deduction is allowed for "any debt which becomes worthless within
the taxable year." Alternatively, the Code permits an accrual-basis
taxpayer to account for bad debts by the reserve method. This is
implemented by § 166(c), which states that,
"[i]n lieu of any deduction under subsection (a), there shall be
allowed (in the discretion of the [Commissioner]) a deduction for a
reasonable addition to a reserve for bad debts."
A "reasonable" addition is the amount necessary to bring the
reserve balance up to the level that can be expected to cover
losses properly anticipated on debts outstanding at the end of the
tax year.
At all times pertinent, Thor has used the reserve method. Its
reserve at the beginning of 1965 was approximately $93,000.
See 64 T.C. at 162. During 1965, Thor's new management
undertook a stringent review of accounts receivable. In the
company's rubber division, credit personnel studied all accounts; a
100% reserve was set up for two accounts deemed wholly
uncollectible, and a 1% reserve was established for all other
receivables.
Ibid. In the tool division, credit clerks
analyzed all accounts more than 90 days past due with balances over
$100; a 100% reserve was established for accounts judged wholly
uncollectible, and an identical collectibility ratio was applied to
accounts under $100 of the same age. A flat 2% reserve was set up
for accounts more than 30 days past due, and a 1% reserve for all
other accounts.
Id. at 162-163. These judgments, approved
by three levels of management, indicated that $136,150 should be
added to
Page 439 U. S. 547
the bad debt reserve, bringing its balance at year-end to a
figure slightly below $229,000.
Id. at 162. Thor claimed
this $136,150 as a deduction under § 166(c).
The Commissioner ruled that the deduction was excessive. He
computed what he believed to be a "reasonable" addition to Thor's
reserve by using the "six-year moving average" formula derived from
the decision in
Black Motor Co. v. Commissioner, 41 B.T.A.
300 (1940),
aff'd on other grounds, 125 F.2d 977 (CA6
1942). This formula seeks to ascertain a "reasonable" addition to a
bad debt reserve in light of the taxpayer's recent chargeoff
history. [
Footnote 24] In
this case, the formula indicated that, for the years 1960-1965,
Thor's annual chargeoffs of bad debts amounted, on the average, to
3.128% of its year-end receivables. 64 T.C. at 163. Applying that
percentage to Thor's 1965 year-end receivables, the Commissioner
determined that $154,156.80 of accounts receivable could reasonably
be expected to default. The amount required to bring Thor's reserve
up to this level was $61,359.20, and the Commissioner decided that
this was a "reasonable" addition. Accordingly, he disallowed the
remaining $74,790.80 of Thor's claimed § 166(c) deduction. Both the
Tax Court, 64 T.C. at 174-175, and the Seventh Circuit, 563 F.2d at
870, held that the Commissioner had not abused his discretion in so
ruling.
B
Section 166(c) states that a deduction for an addition to a bad
debt reserve is to be allowed "in the discretion" of the
Commissioner. Consistently with this statutory language, the courts
uniformly have held that the Commissioner's determination of a
"reasonable" (and hence deductible) addition
Page 439 U. S. 548
must be sustained unless the taxpayer proves that the
Commissioner abused his discretion. [
Footnote 25] The taxpayer is said to bear a "heavy
burden" in this respect. [
Footnote 26] He must show not only that his own
computation is reasonable but also that the Commissioner's
computation is unreasonable and arbitrary. [
Footnote 27] Since it first received the
approval of the Tax Court in 1940, the
Black Motor bad
debt formula has enjoyed the favor of all three branches of the
Federal Government. The formula has been employed consistently by
the Commissioner, [
Footnote
28] approved by the courts, [
Footnote 29] and collaterally recognized by the Congress.
[
Footnote 30] Thor faults
the
Black Motor formula because of its retrospectivity: by
ascertaining current additions to a reserve by reference to past
chargeoff experience, the formula
Page 439 U. S. 549
assertedly penalizes taxpayers who have delayed in making
writeoffs in the past, or whose receivables have just recently
begun to deteriorate. Petitioner's objection is not altogether
irrational, but it falls short of rendering the formula arbitrary.
Common sense suggests that a firm's recent credit experience offers
a reasonable index of the credit problems it may suffer currently.
And the formula possesses the not inconsiderable advantage of
enhancing certainty and predictability in an area peculiarly
susceptible of taxpayer abuse. In any event, after its 40 years of
near-universal acceptance, we are not inclined to disturb the
Black Motor formula now.
Granting that
Black Motor, in principle, is valid, then
the only question is whether the Commissioner abused his discretion
in invoking the formula in this case. Of course, there will be
cases -- indeed, the Commissioner has acknowledged that there are
cases,
see Rev.Rul. 76-362, 1976-2 Cum.Bull. 45, 46 -- in
which the formula will generate an arbitrary result. If a
taxpayer's most recent bad debt experience is unrepresentative for
some reason, a formula using that experience as data cannot be
expected to produce a "reasonable" addition for the current year.
[
Footnote 31] If the
taxpayer suffers an extraordinary credit reversal (the bankruptcy
of a major customer, for example), the "six-year moving average"
formula will fail. [
Footnote
32] In such a case, where the taxpayer can point to conditions
that will cause future debt collections to be less likely than in
the past, the taxpayer is entitled to -- and the Commissioner is
prepared to allow -- an addition larger than
Black Motor
would call for.
See Rev.Rul. 76-362,
supra.
Page 439 U. S. 550
In this case, however, as the Tax Court found, Thor "did not
show that conditions at the end of 1965 would cause collection of
accounts receivable to be less likely than in prior years." 64 T.C.
at 175. Indeed, the Tax Court
"infer[red] from the entire record that collectibility was
probably
more likely at the end of 1965 than it was
[previously], because new management had been infused into
petitioner."
(Emphasis added.) Thor cited no changes in the conditions of
business generally or of its customers specifically that would
render the
Black Motor formula unreliable; new management
just came in and second-guessed its predecessor, taking a "tougher"
approach. Management's pessimism may not have been unreasonable,
but the Commissioner had the discretion to take a more sanguine
view. [
Footnote 33]
For these reasons, we agree with the Tax Court and with the
Court of Appeals that the Commissioner did not abuse his discretion
in recomputing a "reasonable" addition to Thor's bad debt reserve
according to the
Black Motor formula. Thor failed to carry
its "heavy burden" of showing why the application of that formula
would have been arbitrary in this case.
The judgment of the Court of Appeals is affirmed.
It is so ordered.
[
Footnote 1]
In August, 1964, Stewart-Warner Corp., Thor's principal
shareholder (owning approximately 20% of petitioner's outstanding
common shares), agreed with Thor to purchase substantially all of
Thor's assets. Its ensuing examination and audit led Stewart-Warner
to conclude that petitioner's assets were substantially overstated
and its liabilities understated. The purchase agreement then was
rescinded, and Stewart-Warner agreed, instead, to provide
management assistance to Thor.
[
Footnote 2]
Both in his brief, Brief for Respondent 6, 17, 30-31, and at
oral argument, Tr. of Oral Arg. 24-25, the Commissioner has
maintained that the reason for the allowance of Thor's $2.75
million writeoff was that the items were scrapped soon after they
were written off. The Court of Appeals accepted this explanation.
563 F.2d 861, 864 (1977). Thor challenges its factual predicate,
and asserts that 40% of the obsolete parts in fact remained
unscrapped as late as the end of 1967. Reply Brief for Petitioner
8. The record does not enable us to resolve this factual dispute;
in any event, we must accept the Commissioner's explanation at face
value.
[
Footnote 3]
The inventory items broke down as follows:
Raw materials 4,297
Work-in-process 1,781
Finished parts and accessories 33,670
Finished tools 4,344
------
Total number of inventory items 44,092
64 T.C. at 158.
[
Footnote 4]
The operation of Thor's aging formula is well illustrated by a
chart set forth in the opinion of the Tax Court.
Id. at
159. The chart assumes that 100 units of each of five hypothetical
items were on hand at the end of 1964, but that the number of units
sold or used in that year varied from 20-100:
bwm:
ANTICIPATED DEMAND
Units on Units sold Percent of
hand at or used 0-12 13-18 19-24 +24 write-
Item 12-31-64 in 1964 Months Months Months Months down
A 100 20 20 10 10 60
0% 50% 75% 100%
--- --- --- ----
0 5 7.5 60 = 72.5
B 100 40 40 20 20 20
--- --- --- ----
0% 50% 75% 100%
O 10 15 20 = 45.0
C 100 60 60 30 10 0
0% 50% 75% 100%
--- --- --- ----
0 15 7.5 0 = 22.5
D 100 80 80 20 0 0
0% 50% 75% 100%
--- --- --- ----
0 10 0 0 = 10.0
E 100 100 100 0 0 0
0% 50% 75% 100%
--- --- --- ----
O O O O = 0.0
ewm:
[
Footnote 5]
"So here is where I fell back on my experience of 20 years in
manufacturing of trying to determine a reasonable basis for
evaluating this inventory. In my previous association, we had
generally written off inventory that was in excess of one year. In
this case, we felt that that would be overly conservative, and it
might understate the value of the inventory. On the other hand, we
felt that two years . . . would be too optimistic, and that we
would overvalue the inventory [in view of] the factors which affect
inventory, such as technological change, market changes, and the
like, that two years, in our opinion, was too long a period of
time."
"So what we did is we came up with a formula which was somewhat
in between . . . writing off, say, everything over one year as
compared to writing everything [off] over two year, and we came up
with this formula that has been referred to in this Court
today."
App. 57.
[
Footnote 6]
This write-down was formulated as follows:
Write-down Write-down
Type of Inventory Percentage Amount
(1) tool parts and motor
parts at plant A 5 $26,341
(2) raw materials, work-in-process,
and finished goods at plants A and B 10 99,954
(3) hardware items at plant A 50 34,537
--------
$160,832
64 T.C. at 159-160;App. 209.
[
Footnote 7]
The Tax Court found that the finished tools were too specialized
to attract bargain hunters; that no one would buy spare parts,
regardless of price, unless they were needed to fix broken tools;
that work-in-process had no value except as scrap; and that other
manufacturers would not buy raw materials in the secondary market.
64 T.C. at 160-161.
[
Footnote 8]
It appears that 78% of the "excess" inventory at two of Thor's
plants was scrapped between 1965-1971.
Id. at 161;App.
218.
[
Footnote 9]
For a manufacturing concern like Thor, Gross Profit basically
equals Sales minus Cost of Goods Sold. Cost of Goods Sold equals
Opening Inventory, plus Cost of Inventory Acquired, minus Closing
Inventory. A reduction of Closing Inventory, therefore, increases
Cost of Goods Sold and decreases Gross Profit accordingly.
[
Footnote 10]
The Regulations define "method of accounting" to include "not
only the over-all method of accounting of the taxpayer but also the
accounting treatment of any item." Treas.Reg. § 1.446-1(a)(1), 26
CFR § 1.441(a)(1) (1964).
[
Footnote 11]
See 64 T.C. at 166; Tr. of Oral Arg. 17-19. Even if
Thor had made a timely challenge to the Regulations, it is well
established, of course, that they still
"'must be sustained unless unreasonable and plainly inconsistent
with the revenue statutes,' and 'should not be overruled except for
weighty reasons.'"
Bingler v. Johnson, 394 U. S. 741,
394 U. S. 750
(1969), quoting
Commissioner v. South Texas Lumber Co.,
333 U. S. 496,
333 U. S. 501
(1948).
As an alternative to his argument that Thor's write-down was
inconsistent with the Regulations, the Commissioner argues that he
was justified in disallowing the write-down in any event, because
it constituted a "change of accounting method" for which Thor
failed to obtain the Commissioner's prior consent, as required by §
446(e), 26 U.S.C. § 446(e). The Regulations define a change of
accounting method to include "a change in the treatment of a
material item." Treas.Reg. § 1.446-1(e)(2) (i), 26 CFR §
1.446-1(e)(2)(i) (1964). In view of our disposition of the case, we
need not reach this alternative contention.
[
Footnote 12]
E.g., D. Loveman & Son Export Corp. v.
Commissioner, 34 T.C. 776, 796 (1960),
aff'd, 296
F.2d 732 (CA6 1961),
cert. denied, 369 U.S. 860 (1962).
See Schnelwar & Jurgenen, The New Inventory Regulation
in Operation and Other Inventory Valuation Consideration, 33
N.Y.U.Inst. on Fed.Tax. 1077, 1093-1094 (1975); AICPA Accounting
Principles Board, Accounting Research Bulletin No. 43, ch. 4,
Statement 6 (1953), reprinted in 2 APB Accounting Principles 6016
(1973). Judge Raum emphasized in
D. Lovem & Son that
"market" ordinarily means the price the taxpayer must
pay
to replace the inventory; "it does not mean the price at which such
merchandise is resold or offered for resale." 34 T.C. at 796.
[
Footnote 13]
Thor seeks to justify its write-down by citing
Space
Controls, Inc. v. Commissioner, 322 F.2d 144 (CA5 163), and
similar cases. In
Space Controls, the taxpayer
manufactured trailers under a fixed-price contract with the
Government; it was stipulated that the trailers were suitable only
for military use, and had no value apart from the contract. The
taxpayer experienced cost overruns, and sought to write down its
inventory by the amount by which its cost exceeded the contract
sales price. The Court of Appeals, by a divided vote, held that the
write-down was authorized by Treas.Reg. § 1.471-4(b), reasoning
that the taxpayer, in effect, had offered the trailers for sale by
way of the fixed-price contract. 322 F.2d at 151. While not
necessarily approving the Fifth Circuit's decision to dispense with
the "actual sale" rule of § 1.471 4(b), we note that that case is
distinguishable from this one. In
Space Controls, the
fixed-price contract offered objective evidence of reduced
inventory value; the taxpayer in the present case provided no
objective evidence of reduced inventory value at all.
Petitioner's reliance at oral argument on
United States
Cartridge Co. v. United States, 284 U.
S. 511 (1932), is, we think, similarly misplaced. The
taxpayer in that case manufactured ammunition for the Government
during World War I. In 1918, the taxpayer was instructed to stop
production immediately, with a provision that settlement of its
claims for unfinished and undelivered ammunition would be
negotiated later. At the end of its taxable calendar year 1918, the
ammunition was unsalable at normal prices, and settlement
negotiations had not yet begun; the taxpayer, accordingly, wrote
down its 1918 closing inventory to "market," which was agreed to be
$232,000.
Id. at
284 U. S. 519.
The question was whether the taxpayer, in computing its 1918
taxable income, should value its inventory at that figure, or at
$732,000, the sum it ultimately realized upon settlement of its
claims with the Army in 1920-1922. This Court held that, in
accordance with the annual accounting principle, market value
controlled, noting that the taxpayer, at the end of 1918, "had no
assurance as to what settlements finally would be made or that it
ever would receive more than the then market value of the
inventories."
Id. at
284 U. S. 520.
This case, we think, may be said to support, rather than to
conflict with, the result we reach here. Just as Thor cannot write
down its inventory, in the absence of objective evidence
of lower value, because of an anticipated future loss, so the
taxpayer in United States Cartridge could not be required to write
up its inventory, in the absence of objective evidence of
higher value, because of an anticipated future gain. In this
respect, at least, tax accounting travels a two-way street.
[
Footnote 14]
See, e.g., H.R.Doc. No. 140, 87th Cong., 1st Sess., 14
(1961) (the President's tax message); B. Bittker & L. Stone,
Federal Income, Estate, and Gift Taxation 843 (4th ed.1972);
Skinner, Inventory Valuation Problems, 50 Taxes 748-749 (1972);
Schwaigart, Increasing IRS Emphasis on Inventories Stresses Need
for Proper Practices, 19 J.Tax. 66, 69 (1963).
[
Footnote 15]
The Commissioner also contends that Thor's write-down of
"excess" inventory was prohibited by Treas.Reg. § 1.471-2(f), 26
CFR § 1.471-2(f) (1964). That section states:
"The following methods . . . are not in accord with the
regulations in this part: "
"(1) Deducting from the inventory . . . an estimated
depreciation in the value thereof."
"(2) Taking work in process, or other parts of the inventory, at
a nominal price or at less than its proper value."
"(3) Omitting portions of the stock on hand."
See Rev.Rul. 77-364, 1977-2 Cum.Bull. 183 (percentage
write-down of "slow" and "doubtful" inventory violates § 1.471-2
(f)(1)); Rev.Rul. 77-228, 1977-2 Cum.Bull. 182 (deduction from
closing inventory of "excess" items still retained for sale
violates § 1.471-2 (f)(3)). The Court of Appeals and the Tax Court
did not consider these contentions. In view of our disposition, we
need not consider them either.
[
Footnote 16]
Until 1973, § 1.471-2(b) of the applicable Regulations provided
in pertinent part:
"In order clearly to reflect income, the inventory practice of a
taxpayer should be consistent from year to year, and greater weight
is to be given to consistency than to any particular method of
inventorying or basis of valuation so long as the method or basis
used is substantially in accord with §§ 1.471-1 to 1.471-9. An
inventory that can be used under the best accounting practice in a
balance sheet showing the financial position of the taxpayer can,
as a general rule, be regarded as clearly reflecting his
income."
The inventory Regulations were amended in 1973 to require most
taxpayers engaged in manufacturing to use the "full absorption
method of inventory costing," currently set forth in § 1.471-11. T
D. 7285, 1973-2 Cum.Bull. 163, 164; 26 CFR § 1.471-11 (1978). As
part of these amendments, the final sentence of § 1.471-2(b) --
containing the "as a general rule" language -- was deleted;
further, the requirement that inventory practices be
"
substantially in accord with §§ 1.471-1 to
1.479-9" was revised to require that such methods be "in
accord with §§ 1.471-1 through 1.471-11." 26 CFR § 1.471-2(b)
(1978) (emphasis added). The Tax Court and the Court of Appeals
both determined that the 1973 amendments to § 1.471-2(b) were
inapplicable to this case. 64 T.C. at 167; 563 F.2d at 866 n. 11.
We agree.
[
Footnote 17]
"I think it is pretty obvious that [inventory representing a
10-year supply] has inherently less value [than inventory
representing a 1-year supply] because of the things that can happen
to the inventory. Some of it will be lost. Some of it may become
damaged. Some of it will become obsolete because of the
technological change. Some won't be sold, because of the fact that
you have market changes. So we were confronted with the problem, as
anybody in the manufacturing field [would be], of trying to develop
a relationship between inventory quantity and anticipated
usage."
App. 557 (testimony of Thor's president).
[
Footnote 18]
AICPA Accounting Principles Board, Statement No. 4, Basic
Concepts and Accounting Principles Underlying Financial Statements
of Business Enterprises � 171 (1970), reprinted in 2 APB Accounting
Principles 9089 (1973).
See Sterling, Conservatism: The
Fundamental Principle of Valuation in Traditional Accounting, 3
Abacus 109-113 (1967).
[
Footnote 19]
Accord, Raby & Richter, Conformity of Tax and
Financial Accounting, 139 J. Accountancy 42, 44, 48 (Mar.1976);
Arnett, Taxable Income vs. Financial Income: How Much Uniformity
Can We Stand?, 44 Accounting Rev. 482, 485-487, 492-493 (July
1969); Cannon, Tax Pressures on Accounting Principles and
Accountants' Independence, 27 Accounting Rev. 419, 419-422
(1952).
[
Footnote 20]
See, e.g., McClure, Diverse Tax Interpretations of
Accounting Concepts, 142 J. Accountancy 67, 849 (Oct.1976); Kupfer,
The Financial Accounting Disclosure of Tax Matters; Conflicts With
Tax Accounting Technical Requirements, 33 N.Y.U.Inst. on Fed.Tax.
1121, 1122 (1975); Healy, Narrowing the Gap Between Tax and
Financial Accounting, 22 Tulane Tax Inst. 407, 417 (1973); A
Challenge: Can the Accounting Profession Lead the Tax System?, 126
J. Accountancy 6, 89 (Sept.1968).
[
Footnote 21]
E.g., Raby & Richter,
supra at 44; Arnett,
supra at 48B; 12 J.Accountancy,
supra at 68.
[
Footnote 22]
Arnett,
supra at 492 (noting that there are "many and
diverse
acceptable' practices in valuing inventories,
depreciating assets, amortizing or not amortizing goodwill," and
the like); 126 J.Accountancy, supra at 69 (noting that
"methods of determining inventory costs vary widely, and various
methods, if consistently applied, will be acceptable for accounting
purposes"); Eaton, Financial Reporting in a Changing Society, 104
J. Accountancy 25, 26 (Aug.1957); Cox, Conflicting Concepts of
Income for Managerial and Federal Income Tax Purposes, 33
Accounting Rev. 242 (1958); Cannon, supra at 421
(suggesting that accountants "are quite prone to define `generally
accepted' as `somebody tried it'").
[
Footnote 23]
Thor's experts did not testify that the company's write-down
procedures were the only "generally accepted accounting practice."
They testified merely that Thor's inventory needed to be written
down, and that the formulae Thor used constituted a "reasonable"
way of doing this. App. 166, 184, 196.
[
Footnote 24]
The details of the calculation are set out in
Black Motor
Co. v. Commissioner, 41 B.T.A. at 302.
See 2 CCH 1978
Stand.Fed.Tax Rep. � 1624.0992; Whitman, Gilbert, & Picotte,
The
Black Motor Bad Debt Formula: Why It Doesn't Work and
How to Adjust It, 35 J.Tax. 366 (1971).
[
Footnote 25]
Malone & Hyde, Inc. v. United States, 568 F.2d 474,
477 (CA6 1978);
Business Dev. Corp. of N.C. v. United
States, 428 F.2d 451, 453 (CA4),
cert. denied, 400
U.S. 957 (1970);
United States v. Haskel Engineering &
Supply Co., 380 F.2d 786, 789 (CA9 1967);
Patterson v.
Pizitz, Inc., 353 F.2d 267, 270 (CA5 1965),
cert.
denied, 383 U.S. 910 (1966);
Ehlen v. United States,
163 Ct.Cl. 35, 42, 323 F.2d 535, 539 (1963);
James A. Messer
Co. v. Commissioner, 57 T.C. 848, 864-865 (1972).
[
Footnote 26]
Atlantic Discount Co. v. United States, 473 F.2d 412,
414-415 (CA5 1973) (citing cases);
Consolidated-Hammer Dry
Plate & Film Co. v. Commissioner, 317 F.2d 829, 834 (CA7
1963).
[
Footnote 27]
E.g., Malone & Hyde, Inc. v. United States, 568
F.2d at 477;
First Nat. Bank of Chicago v. Commissioner,
546 F.2d 759, 761 (CA7 1976),
cert. denied, 431 U.S. 915
(1977).
[
Footnote 28]
See, e.g., Rev.Rul. 76-362, 1976-2 Cum.Bull. 45, 46
("[A]s a general rule, the
Black Motor formula may be used
to determine a reasonable addition to a reserve for bad debts"
under § 166(c)).
[
Footnote 29]
E.g., Atlantic Discount Co. v. United States, 473 F.2d
at 413, 415;
Ehlen v. United States, 163 Ct.Cl. at 45, 323
F.2d at 540-541;
James A. Messer Co. v. Commissioner, 57
T.C. at 857, 865-866.
[
Footnote 30]
See § 585(b)(3) of the 1954 Code, 26 U.S.C. § 585(b)(3)
(using "six-year moving average" formula as alternative method of
computing reasonable addition to bad debt reserve for banks); §
586(b)(1) (using "six-year moving average" formula to compute
reasonable addition to bad debt reserve for small business
investment companies).
[
Footnote 31]
E.g., Westchester Dev. Co. v. Commissioner, 63 T.C.
198, 212 (1974),
acq., 1975-2 Cum.Bull. 2 (Commissioner
abused discretion in invoking
Black Motor where taxpayer's
recent bad debt experience was "wholly unrepresentative" given its
"comparatively brief operational history").
[
Footnote 32]
E.g., Calavo, Inc. v. Commissioner, 304 F.2d 650,
651-652, 654 n. 4, 655 (CA9 1962) (extraordinary addition to
reserve to cover losses on accounts due from debtor who recently
became insolvent).
[
Footnote 33]
Indeed, as has been noted, a significant portion of Thor's
addition to its reserve reflected blanket aging of accounts. Both
the Treasury, Rev.Rul. 76-362, 1976-2 Cum.Bull. 45, 46, and the
courts,
United States v. Haskel Engineering & Supply
Co., 380 F.2d at 787, 789;
James A. Messer Co. v.
Commissioner, 57 T.C. at 857, 866, have held that such
mechanical formulae are inadequate to overcome the Commissioner's
discretionary invocation of Black Motor under § 166(c).