"On written-down value" refers to the diminishing value. (See page 175.)

Like all rates of depreciation stated herein, those contained in the foregoing table are suggestive only. They are particularly valuable, however, in that they are drawn from actual Income Tax experience.

Where it is found that an excessive rate of depreciation was Adjusting deducted in past years, amended returns may be Excess De- filed for such years and the additional tax will be preciation. assessed without penalty.

"This office is in receipt of your letter of the 8th instant, in which you state that a corporation in its returns for the years 1911, 1912 and 1913 claimed depreciation of 122% on the value of its machinery; that in 1917 an income tax inspector examined the books and recommended that depreciation at the rate of 5% be allowed and as a result, additional taxes were assessed against the corporation for the years 1911, 1912 and 1913, based upon the increase in net income resulting from the reduction of depreciation from 121⁄2 to 5%; and that another corporation engaged in the same line of business and using the same kind of machinery charged off 12% for depreciation on the same, but the books of this corporation were never examined and you ask what penalty, if any, the latter company will be required to pay for the years 1911, 1912 and 1913 if it now makes a claim that its calculations for such years were based on an excessive rate of depreciation.

In reply, you are informed that no penalty will attach to the corporation if it files amended returns reducing its depreciation deduction from 122 to 5% on its machinery. The amended returns should be prepared and filed with the Collector of Internal Revenue for its district with a letter of transmittal, stating the reason the amended returns were filed. The Collector will then notify this office and an additional tax of 1% will be assessed against the corporation due to the increase in its net income on account of the reduction of its depreciation deduction from 121⁄2 to 5%." (Extract from letter to the First National Bank, Cleveland, Ohio, by Deputy Commissioner L. F. Speer, dated Nov. 16, 1917, published in the Income Tax Service of the Corporation Trust Co.)

CHAPTER VII

BOOKKEEPING SUGGESTIONS

PREPARATION OF INCOME TAX RETURNS OF CORPORATIONS

Methods of
Bookkeep-

ing.

The amended law contains a provision in regard to the keeping of accounts, as follows:

"A corporation, joint-stock company or association, or insurance company, keeping accounts upon any basis other than that of actual receipts and disbursements, unless such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned.”

The same provision is made with respect to the accounts of individuals.

This permits the individual or corporation, that employs a method of bookkeeping from which a return cannot be prepared in the prescribed form, to render the report according to the method of bookkeeping employed, provided only that the books from which the return is made reflect the correct income. The return, however, must, in every case, be made on the blank provided by the Government, with full and complete explanations as to the method employed.

The dominant and foremost requisite in the preparation of income tax returns is To REPORT THE FACTS. The method employed to arrive at the facts is of considerable importance," but secondary. A variance from the prescribed classification of income and expenses may be unavoidable; a deliberate disregard of the facts, by either omission or declaration, is tantamount to misrepresentation.

The income and expenses should be classified as prescribed

by the return unless the nature of the business is such that it does not permit of such classification or unless the books of account are kept in conformity with regulations of some department of the Government requiring the keeping of books according to "uniform systems of accounting," as in the case of corporations coming under the Interstate Commerce Commission.

The books must be so kept that each and every item set forth in the return of annual net income may be readily verified by an examination of the books of account.

"The books of a corporation are assumed to reflect the facts as to its earnings, income, etc. Hence they will be taken as the best guide in determining the net in- Books of come upon which the tax imposed by this act is Account calculated. Except as the same may be modified Best Guide by the provisions of the law, wherein certain de- to Income. ductions are limited, the net income disclosed by the books and verified by the annual balance sheet, or the annual report to stockholders, should be the same as that returned for taxation." (Regulations 33, Article 183.)

Internal

"For the purpose of verifying any return, made pursuant to this act, the Commissioner of Internal Revenue may, by any duly authorized revenue agent or Examinadeputy collector, cause the books of such corpo- tion of ration to be examined, and if such examination Books by discloses that the corporation is liable to tax in Revenue addition to that previously assessed, or assess- Officers. able, the same shall be assessed and shall be payable immediately upon notice and demand. For the purpose of such examination, the books of corporations shall be open to the examining officer, or shall be produced for this purpose upon summons issued by any properly authorized officer." (Regulations 33, Article 186.)

Although there has been no ruling upon specific methods of accounting under the present income tax law, Accruals. it is clear that corporations or individuals keeping

accounts upon the plan of accruing income and expenses or deferring prepayments, may prepare their returns Prepayaccordingly. From an accounting viewpoint this ments. is the only correct method whereby the true profit or loss of

a business may be deduced. But the method, if employed, must be used consistently and with limitation. In no case shall an expense account for a tax year or fiscal year be charged with a greater amount than is actually incurred or accrued therein and for which the business has received value in such fiscal or tax year; that is to say, no deduction shall be made of an amount in excess of that actually chargeable against the operations of the year (fiscal or calendar) for which the return is made. Prepayments may be deferred, that is, such part of expenses as are prepaid may be deducted from expenses and treated as "deferred assets" or "prepayments" in the balance sheet.

The accounts most commonly accrued or deferred are interest, taxes, insurance, rents, salaries, commissions and income taxes withheld, but the principle is applicable to all classes of income and expenses.

No accruals shall be deducted from income unless they appear upon the books of account and represent expenses actually incurred or accrued during the year.

Wherever the expressions "actually paid" or "paid during the year" appear herein, when applied to individuals or corporations keeping their accounts upon the "accrual basis," such accruals are comprehended therein.

Apart from facilitating the preparation of income tax returns, bookkeeping suggestions would be out of place here.

Distribution of Accounts.

But a great deal of time and work may be saved to the bookkeeper and to the executive who is responsible for the contents of the report, by employing a method of bookkeeping that will, without analysis of accounts, present to immediate view in a trial balance, the component parts called for by the income tax return. This can be accomplished only by a suitable distribution of accounts of income and expenses, assets and liabilities.

Merchandise sales should be credited to a separate account in the ledger. Where departmental accounts are kept, the ledger should contain a separate sales account for Sales. each department or each class of commodity. The sales called for by the supplementary statement of the income tax return under "Gross Income from Operations" should be

the net sales, i. e., gross sales (amounts charged to customers) less returns, allowances and discounts allowed on sales.

Goods returned by customers should be charged to a separate account unless they are, in aggregate, so small a proportion of the sales that a separate account would not be Return justified. If no separate account is kept, the re- Sales. turns should be charged to Sales Account. The advantage of a separation-which bears no relation to the preparation of a tax report is that a monthly trial balance discloses, at a glance, the proportion of returns to the volume of sales.

As stated under "Sales," goods returned by customers should, for the income tax report, be deducted from amount shown by Sales Account (Gross Sales).

Ordinary allowances on goods sold, such as claims by reason of breakage, short shipment, overcharges, defective goods, etc., should be charged to an Allowance Account and Allowdeducted from sales for the income tax return. ances. Exceptional allowances, such as unrecovered shipments lost in transit, for which the shipper is responsible and cannot recover from the transportation company, should be charged to an account that by its title is descriptive of its contents, as "Goods Lost in Transit," and should be so stated in the income tax return. All losses, to be deductible from the income tax return, must be charged off in the year the loss is sustained. "Discounts allowed" on sales should be charged to an account bearing that title. "Discounts received" on Discounts goods purchased should be credited to a separate Allowed. account so entitled. For income tax purposes discounts allowed to customers are a reduction of the gross sales, and Discounts discounts received, as a trade allowance or for Received. prepayment of goods purchased, are a reduction of the cost of goods bought.

Rebates.

Rebates on sales that are allowed by way of commissions, or as a reward for selling certain quantities of commodities, should be carried in a separate account in the ledger and treated in the income tax return as a general expense under "Deductions" and included in "Commissions" in the supplementary statement under "General Expenses."

Merchandise purchased should be charged to a "Purchase