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included in the inventory should be vested in the taxpayer and goods merely ordered for future delivery and for which no transfer of title has been effected should be excluded. The inventory should include merchandise sold, but not shipped to the customer at the date of the inventory, together with any merchandise out upon consignment, but if such goods have been included in the sales of the taxable year, they should not be taken in the inventory. It should also include merchandise purchased, although not actually received, to which title has passed to the purchaser. In this regard care should be exercised to take into the accounts all invoices or other charges in respect of merchandise properly included in the inventory, but which is in transit or for other reasons has not been reduced to physical possession.

Valuation of Inventories. (Art. 1582. Reg. No. 45, 1918.) "Inventories should be valued at (a) cost or (b) cost or market, whichever is lower. Whichever basis is adopted must be applied to each item and not merely to the total of the inventory; that is, if for instance basis (b) is adopted, the value of each item in the inventory will be measured by market if that is lower than cost, or by cost if that is lower than market. A taxpayer may, regardless of his past practice, adopt the basis of cost or market, whichever is lower, for his 1918 inventory, provided a disclosure of the fact and that it represents a change is made in the return. Thereafter changes can be made only after permission is secured from the Commissioner. Inventories should be recorded in a legible manner and properly computed and summarized, and should be preserved as a part of the accounting records of the taxpayer. Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be the goods most recently purchased."

Inventories at Cost. (Art. 1583. Reg. No. 45, 1918). “Cost means:

"(1) In the case of merchandise purchased, the invoice price less trade or other discounts except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer, provided a consistent course is followed. To this net invoice price should be added transportation or other necessary charges incurred in acquiring possession of the goods.

“(2) In the case of merchandise produced by the taxpayer, (a) the cost of raw materials and supplies entering into or consumed in connection with the product, (b) expenditures for direct labor, (c) indirect expenses incident to and necessary for the production of the particular article, including in such indirect expenses a reasonable proportion of management expenses, but not including any cost of selling or return on capital whether by way of interest or profit. In any industry in which the usual rules for computation of cost of production are inapplicable, costs may be approximated upon such basis as may be reasonable and in conformity with established trade practice in the particular industry.

Inventories at Market. (Art. 1784. Reg. No. 45, 1918.) "Market means the current bid price prevailing at the date of the inventory for the particular merchandise, and is applicable to goods purchased and on hand and to basic materials in goods in process of manufacture and in finished goods on hand, exclusive, however, of goods on hand or in process of manufacture for delivery upon firm sales contracts at fixed prices entered into before the date of the inventory. Where no open market quotations are available the taxpayer must use such evidence of a fair market price at the date or dates nearest the inventory as may be available to him, such as specific transactions in reasonable volume entered into in good faith, or compensation paid for cancellation of contracts for purchase commitments. The burden of proof will rest upon the taxpayer in each case to satisfy the Commissioner of the correctness of the prices adopted. It is recognized that in the latter part of 1918, by reason among other things of governmental control not having been relinquished, conditions were abnormal and in many commodities there was no such scale of trading as to establish a free market. In such a case, when a market has been established during the succeeding year, a claim may be filed for any loss sustained in accordance with the provisions of section 214 (a) (12) or section 234 (a) (14) of the statute.

Sec. 214

Adjustment of Inventories After Close of
Taxable Year. Income Tax Law.
(a-12) (Individuals.] (a-14)

(a-14) (Corporations.] “At
the time of filing return for the taxable year 1918 a
taxpayer may file a claim in abatement based on the fact
that he has sustained a substantial loss (whether or not
actually realized by sale or other disposition resulting
from any material reductions (not due to temporary fluc-
tuation) of the value of the inventory for such taxable
year, or from the actual payment after the close of such
taxable year of rebates in pursuance of contracts entered
into during such year upon sales made during such year.
In such case payment of the amount of the tax covered
by such claim shall not be required until the claim is de-
cided, but the taxpayer shall accompany his claim with a
bond in double the amount of the tax covered by thə
claim, with sureties satisfactory to the Commissioner,
conditioned for the payment of any part of such tax
found to be due, with interest. If any part of such
claim is disallowed then the remainder of the tax due
shall on notice and demand by the collector be paid

by the taxpayer with interest at the rate of i per centum
per month from the time the tax would have been due
had no such claim been filed. If it is shown to the
satisfaction of the Commissioner that such substantial
loss has been sustained, then in computing the taxes im-
posed by this title and by Title III the amount of such
loss shall be deducted from the net income. (b) If no
such claim is filed, but it is shown to the satisfaction of
the Commissioner that during the taxable year 1919
the taxpayer has sustained a substantial loss of the char-
acter above described then the amount of such loss shall
be deducted from the net income for the taxable year
1918 and the taxes imposed by this title and by Title III
for such year shall be redetermined accordingly. Any
amount found to be due to the taxpayer upon the
basis of such redetermination shall be credited or
refunded to the taxpayer in accordance with the provi-
sions of section 252."

Inventories Prescribed in Certain Cases. (Reg. No. 33, 1918, 1353.) “Gross income for the purpose of returns of manufacturing companies shall consist of the total sales plus the inventory at the end of the year less the sum of the cost of goods or materials purchased during the year and the inventory at the beginning of the year.”

(Reg. No. 33, 1354.) "For the purpose of returns gross income of mercantile companies shall consist of the total sales plus the inventory at the end of the year less the sum of the cost of goods purchased during the year and the inventory at the beginning of the year.”

A. THEORY QUESTIONS

1. What duties and responsibilities has an auditor in connection with inventories of goods on hand?

C. P. A. Me. and Ore. 2. What is turnover and of what use should an auditor make of it in an audit of a merchandising business?

C. P. A. Ind. 3. A manufacturing company purchased a large stock of material during the year at low prices, but at the time of the annual inventory values had abnormally increased. How, in your opinion, should the inventory and loss and gain be shown on the books?

C. P. A. Mich. 4. You are asked by a. client to treat inventories at the time of closing the books. Should they be figured at cost or market price or otherwise? Is the common, old-fashioned method of adding the inventory of merchandise on hand to the credit side of the Merchandise account before closing the books, theoretically correct? Explain fully.

C. P. A.Mich. 5. Explain what is understood by a "book inventory" and indicate in what circumstances and for what purposes you would consider such a record to be of use in a manufacturing business

(a) For current information.
(b) For use in the preparation of interim statements of

accounts.
(c) For use in the preparation of final yearly or half-

yearly accounts. Assuming your client decided to rely entirely upon such book records, what steps should be taken to guard their accuracy?

Inst. Ex. 1918. 6. An inventory is submitted to you certified by the manager of a business. Mention some of the principal steps you would take to confirm the correctness of the inventory figure appearing in the Balance Sheet.

Inst. Ex. 1917. 7. A company which keeps no perpetual inventory records but takes an inventory annually on December 31, suffers a fire loss on March I. How would you proceed to compute the inventory on hand at that date?

Inst. Ex. 1917. 8. "Inventory of merchandise should be carried at cost or market, whichever is lower." Do you assent to this proposition? Can you suggest circumstances in which you would approve a departure therefrom? Would you be influenced by events or conditions subsequent to the date of closing the accounts? Give reasons.

Inst. Ex. 1918.

B. ACCOUNTING PROBLEMS.

in con

nd Ore. auditor

A. Ind. tock of

of the How, in

shown .. Mich.

at the cost or shioned

to the books, .Mich. entory" ses you acturing

1. From the following particulars you are required to determine the value of the merchandise on hand: Inventory at beginning of period.

$75,000.00 Purchases.

200,000.00 Wages...

65,000.00 Freight Inward.

3,000.00 Gross Profit...

56,780.20 Discount on Sales..

4,540.00 Sales ....

360,784.80 Discounts Received on Purchases.

1,760.00

C. P. A. Ind. 2. Arrange the following in a Balance Sheet for presentation to a banker.

Furniture and Fixtures.... $15,000.00
Stock of Merchandise at cost.. 50,000.00
Accounts Receivable..

35,000.00
Officers' Accounts.

30,000.00 Bonds Owned...

10,000.00 Capital Stock.

$75,000.00 Accounts Payable..

20,000.00 Trade Notes Payable.

40,000.00 Surplus...

5,000.00

[blocks in formation]

$140,000.00 $140,000.00

C. P. A. III. 3. You are asked to certify to the Balance Sheet of a certain company. Upon investigation, you find that the inventories have been priced at cost, although the market prices at the closing date were 10% lower on iron and 5% higher on wood. At the date of your report the market on iron had risen to 5% above cost, and the market on wood had fallen to 15% below cost. How would you dispose of these items in the Balance Sheet?

C. P. A. Ill. 4. You are called in as a public accountant to assist a firm in the preparation of a Balance Sheet as at December 31, 1915, and in the balancing of the books. After examination you find the following facts: (1) On January 3 three items, amounting to $50,000.00 in

the aggregate, were received in cash, but were entered as at December 31, 1915. No Cash account is kept in

the general ledger. (2) An item was posted to the credit of an account in the

sales ledger from the cash book as $5,050.00 instead of $50.50. A Sales Ledger control account is kept in the general ledger.

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