Industrial Lumber Co. v. Commissioner , 20 B.T.A. 394 ( 1930 )

INDUSTRIAL LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Industrial Lumber Co. v. Commissioner

Docket No. 29977.

United States Board of Tax Appeals

20 B.T.A. 394; 1930 BTA LEXIS 2128;

July 30, 1930, Promulgated

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The action of the respondent in rejecting the petitioner's original inventory and its alternative offer of a corrected inventory reduced by anticipated shrinkage and estimated losses through degrading and discount is approved.

W. W. Spalding, Esq., for the petitioner.

B. M. Coon, Esq., for the respondent.

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LANSDON

The respondent asserted a deficiency in income and profits tax against the petitioner for the calendar year 1920 of $38,088.78, all of which is in dispute. In support of its appeal the petitioner alleges:

(a) Respondent erred in refusing to accept petitioner's closing 1920 inventory, taken on the basis of cost or market, whichever was lower, this basis having been applied consistently by petitioner to the inventory, grade by grade, item by item.

(b) Respondent erred in applying the basis of cost or market, whichever was lower, to petitioner's closing 1920 inventory, in that respondent refused to allow appropriate deductions from the market value of the entire inventory, considered as one unit, for shrinkage, breakage, degrading, and discounts.

FINDINGS OF FACT.

The petitioner is a Louisiana corporation engaged in the manufacture and sale of lumber. Its principal office and mill is in Elizabeth, La., but it has other mills located at Calcasieu and Oakdale. About 25 per cent of its product as it came fresh cut from the mill was in the form of railroad bridge timbers and beams, which were sold green, while the remaining 75 per cent required further processing before marketing. Under the methods followed by the petitioner about one-third of this residue, or 25 per cent of the whole, was cured in kilns, while the remainder or 50 per cent of the whole, was air dried in the yards. Kiln drying required from three to five days and air drying from three to four months. After curing, the stock not held for sale in the rough was sent to the planing mills, where it was dressed and trimmed in final preparation for market.

In the commercial grading of petitioner's stock five grades, determined by the presence or absence of knots or other defects in the boards, were recognized, viz.: "B-and-better" and grades 1, 2, 3, and 4. The first mentioned represented lumber most free from commercial defects and commanded the highest market price. The others in their order represented the lower qualities, with selling prices graduating downward in varying degrees. These prices, according to condition and market demands, have a possible variance of from $120 per thousand feet for the highest finished grade to $8 per thousand for the lowest rough grade.

In closing its books for the year the petitioner invoiced its stock on hand at the actual market prices then prevailing for each grade. It then took as a cost price unit for the items within these grades the quotient derived by dividing their total cost with the whole number of feet on hand in all of the grades. The lower of these units, cost or market value, affecting the items on hand, was extended into the closing column of the invoice and then totaled as the closing inventory for the year. In auditing the petitioner's return for the year the respondent rejected the cost units employed by it in its comparisons as inadequate to reflect the true cost, and increased the closing inventory from $449,035.56, as determined by it, to $580,269.13. The petitioner thereafter prepared an amended inventory based upon cost or market, whichever was lower, but using in its comparison the total cost value and the total market value of its stock without regard to grades. In connection with this amended inventory it claimed the right to deduct from the total thereof amounts as follows: $38,434.68 on account of estimated shrinkage and breakage, $34,880.16 on account of estimated loss through degrading, and $6,361.89 on account of discounts.

The respondent accepted the values as fixed by the petitioner in its amended inventory, but refused to allow the adjustments claimed on account of shrinkage, degrading, breakage, and discount.

OPINION.

LANSDON: We have for consideration here two inventories, each purporting to have been made upon basic values of cost or market, whichever was lower. In the original inventory the petitioner separately assigned to each of the five grades of lumber in stock its then prevailing market price. With these prices, which varied from the highest for "B-and-better" grade to the lowest for grade "4" common, it compared a so-called average cost unit price, which applied equally to each board foot of lumber in its entire stock, without regard either to actual cost of production or market price. In other words, it applied the actual sale price for market, but not the actual cost price for cost. In the , where the respondent urged the use of this system, we held that it would be accurate "only if the ratio between the total quantity produced and the quantity of each grade produced equaled the ratio between the total inventory list and the grade inventory list." There is no claim here that these ratios, by grade or otherwise, between production and final inventory have been maintained or could be maintained under the methods followed by the petitioner. The record does show, however, a wide disparity in actual cost of production of a considerable portion of the petitioner's stock, as, for example, in the cases of bridge timbers and railroad beams, and in the kiln-dried dressed lumber. The first of these, which constitutes 25 per cent of the mill output, is marketable green from the mill without further cost, while the latter requires additional processing and repeated handling, which not only adds to the expense, but degrades and decreases the quantity of merchantable lumber at each successive step.

In , where the taxpayer had first inventoried its lumber by using the average unit cost rather than the actual cost of each separate grade, we allowed it to amend its return and substitute the latter, upon the ground that it more nearly reflected the true income. We think, under the facts shown, that the respondent was justified in applying the same rule in his audit of the petitioner's return in this instance and his act in rejecting the inventories offered must be approved.

In respect to the amended inventory, which is based upon values obtained by comparison of the grand totals of the actual cost and market value of every item of the petitioner's stock on hand, without regard to grade, the respondent and petitioner are in accord, except as to the reductions claimed from these values on account of estimated losses which the petitioner claims its business experience shows it must ultimately sustain on account of degrading, wastage, and discount before it can convert its stock into cash. In support of its claim for allowance of these deductions the petitioner introduced evidence to show that inventories, by board measure, made of lumber as it comes green from the mill and is placed in the pile, of necessity includes much unmerchantable lumber; also, that in further process and successive handling, unavoidable loss is sustained through trimming and breakage which greatly reduces the board footage of original inventories. The petition further establishes that a shrinkage in value of its stock is likewise sustained through successive degradings; also that time required in curing and processing, at least a part of its stock, is from 90 to 120 days. These facts, it contends, entitle it to now take the losses claimed, based upon estimates, and cites our decisions in ; ; ; and , in support thereof.

The character of the stock included in the petitioner's inventories is so essentially different from that invoiced in the cases cited that we are unable to accept such decisions as authority to support the method sought to be employed here. There are other facts also which differentiate those cases from the one at bar and make our conclusion therein inapplicable to the facts in this proceeding. The appellants in the Hutchins Lumber & Storage Co. and the May Lumber Co. cases were not manufacturers of lumber. Nor did either include in its inventory any raw or unfinished product. They were dealers in finished lumber bought at a definite price, after the losses here sought to be determined had been sustained by the manufacturer and no doubt absorbed in that price. The complicated questions, therefore, of loss in processing through trimming, shrinkage, degrading, etc., were in no way involved, nor was actual cost in doubt. In the Hutchins Lumber Co. case, supra, the unsalable lumber was taken out of the stacks and counted piece by piece. The loss was not only sustained, but the quantity of damaged lumber was determined. In the May Lumber Co. appeal supra, the question was one of loss to stock held in reserve by a planing mill and although an estimate of the amount of this loss was accepted, yet it was because, as found by the Board, it was based upon actual experience over a long period of years. In such connection the Board in its opinion said in part:

* * * Each year a physical inventory was carefully made by an officer and director of the petitioner, who actually counted and recorded all the lumber in stock. The amount of the loss determined for each year was arrived at with the same precision and care, and represents in our opinion the best estimate which could be obtained. The fact that this estimate was stated in terms of a percentage does not detract from the uniformity or consistency of the method used. * * *

Without going into any further analysis of the cases cited by the petitioner, we are of the opinion that none of them support the doctrine contended for by it as applied to the facts in this case. Were the petitioner a dealer in finished products and not a manufacturer whose stock in trade was so largely made up of goods in varying stages of production, we might feel inclined to accept some of the views so earnestly urged; but from the view we take of the facts here, the so-called losses by which it seeks to reduce the value of its closing inventory for the taxable year must be considered as part of the cost of its products in the course of manufacture and not deductible as losses in that year.

Decision will be entered for the respondent.